Category: Opinion

One Place to Look for Low Market Risk with Home Run Potential

Posted on by phoffman@channelchek.com
Image Credit: Sam Valadi (Flickr)

Less Attention is Being Paid to SPACs, But the Risk Reward Scenario Can’t Be Ignored

Uncertain markets warrant additional attention to risk versus possible reward on investments, especially when the least risky money funds pay 4% or more. This need to minimize risk, yet desire to have the opportunity to, at a minimum, beat inflation and in the best case scenario, hit a grand slam, might cause investors to revisit the hot investment of 2021. Like most investment sectors that do well, back then it became too crowded with issuance and overpromise. But the Special Purpose Acquisition Corp (SPAC), is getting far less attention these days – yet the relatively low risk for investors, and low competition for acquisition corps. to find that “unicorn,” it could increase the percentage of SPAC home runs. All the while limiting potential downside returns.

Special Purpose Acquisition Corps.

Investors that just want to make (or lose) the returns of a major index may not find investing in individual SPACs, at any stage, fits their investment approach. But the SPAC legal structure could suit investors that want to minimize their downside to a more or less known potential, and maximize their possible above average returns – SPACs may match these investment objectives better than alternatives.

Let’s cover risk first. SPAC investors have limited risk as their investment is held in a trust account until the SPAC identifies a target company and completes a merger. If the SPAC fails to identify a target, the investors will return their money, plus today’s higher accrued interest rates, less management, legal, and administrative fees. That is to say, a SPAC purchased as an IPO could be expected to be up or down one or two percent from the initial (usually $10) IPO price.

As ulcer-producing volatility in the major indices over the past year has shown, the feeling of having a floor on losses is comforting. The monetary distance to this floor is reduced if a post SPAC IPO, still looking for a target is trading below the $10 IPO price.

Does low risk mean low returns? SPACs offer the potential for low risk/high returns for investors who get in before an announced target. If the SPAC is successful in identifying and merging with a high-growth company, the share price could increase significantly. The targets often are successful private companies with tremendous potential, more of the potential could be realized with an injection of cash from the SPAC merger/acquisition. that would be able to expand.

What if an investor is opposed to the proposed merger? SPAC investors have the flexibility to decide whether or not to participate in the merger with the target company. If they choose not to participate, they can redeem their shares for the original investment amount plus interest, less administrative costs. This is another way that investors minimize their downside risk.

What are the risks? Investing in SPACs also comes with potential risks, such as the possibility of the SPAC failing to identify a suitable target company, this would essentially have tied up the investment capital used to purchase the SPAC. Another risk is the target company not performing as expected after the merger; as mentioned above, the pre-merger investor gets to decide if they opt in or opt to have pro-rata share of initial investment returned. As with any investment, it’s important to do your due diligence, look at any changes in the regulatory environment, and carefully evaluate the structure and goals.

What Does SPAC Investment Success Look Like?

Not all SPACs find a suitable target. An investor wants the management team exploring possibilities to be diligent and picky. But despite the large number of SPACs that have gone no place during the abundance offered in 2021, it’s easy to find examples of why investors like the market. Below are three very different examples of what success looks like:

Source: Koyfin

In green is Digital World Acquisition Corp. (DWAC). It’s the only stock represented below that is pre-merger. The initial IPO was for $10 back in April 2021. Recent numbers show that a failure to merge with its current target, Trump Media, would result in approximately a $10 per share liquidation. Initial investors will have lost opportunity should this occur as they took the full ride from beginning to this possible end.

In October after the IPO,  Digital World announced it had reached a preliminary agreement to merge with the digital media company founded by the former U.S. president. The shares skyrocketed over  900%. For those that bought the once $10 shares for $96, they may not have called this right, for those that purchased around the offer price, their risk of losing money is low, and they currently sit at a 34% profit.

In orange is Hostess (TWNK). This has been a SPAC success story which dates back to 2016 when there were only 13 SPAC IPOs all year. By comparison, there were 613 in 2021, and to date only 8 in 2023. Fewer SPACs chasing the same potential targets could work in investors’ favor. Many of the SPACs that are still less than two year old are still shopping. However most of those arrangements are expected to be returning shareholder funds. While Hostess is up 103% since March three years ago, it has gained 236% since the merger announcement.

Bowlero (BOWL), shown in blue, announced the merger with Isos Acquisition Corp. on July 1, 2021. The merged company would have at first disappointed investors as it dipped slightly. This is understandable as investing in leisure did not seem that it would offer quick gratification, as the pandemic hit this sector hard. However, the stock is up 54% in less than two years and up 58% YTD.

Shown here in purple, DraftKings (DKNG) merged April 24, 2020. Post merger, for those who held the Diamond Eagle Acquisition SPAC shares, they saw the stock jump 5% on the day of the announcement, eventually rise over 350%, and over time come back down to match the initial jump, 6% YTD.

Above are success stories, of varying degrees. There are many SPACs that don’t find the ideal merger partner, for the initial purchasers at $10, or those buying shares sub-$10 after the offering, their risk can be considered lower than the overall market. The potential for large gains, exists.

What Does a SPAC Investment Failure Look Like?

The most an investor will lose in an index fund investment approximates the decline of the index less management fees. The most an investor in any of the individual stocks in a major market index can lose is all of their investment. When an investor takes part in a SPAC IPO or purchases shares trading below the IPO price later, they have claim to funds held in escrow that would have been used for an acquisition. These funds seldom grow or shrink by more than 2%. SPAC investors could look at the risk of losing $2 per share (2%), versus possibly gaining double or triple-digit returns as better than market risk. But investors have lost some of their initial investment, and once the deal is struck, voted on by shareholders, and moves forward, the investment risk goes from very low, to just as risky as any other company traded. In other words, up to 100%.

Take Away

Low-risk and high-reward investments may not suit all portfolios. But for those that like to reduce the odds of loss, the glut of previously offered SPACs that are retiring this year, coupled with the lack of new offerings, could set the stage for easier target hunting for unmatched SPACs. Also, older SPACs trading at or below the enterprise value may be worth looking at, the cash in the escrow accounts are earning today’s yields, and may even be worth more than the share price.

To look for current opportunities of  companies that have announced a merger, but not yet completed one, a source of information is Channelchek. Earlier this month, Better World Acquisition Corp. (BWAC) announced it will be merging with Heritage Distilling Co. The combined company expects to trade under the ticker CASK. A current research report detailing the planned acquisition along with valuation is made available here, from Noble Capital Markets.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.spacanalytics.com/

https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin

https://www.bloomberg.com/news/articles/2022-08-15/burst-of-broken-spac-deals-sends-jitters-through-battered-sector#xj4y7vzkg

https://www2.deloitte.com/us/en/pages/audit/solutions/spac-services.html?id=us:2ps:3gl:spacB:awa:aud:050122:ad1:kwd-974274046309:spac%20transactions:p:c&gclid=CjwKCAjwzuqgBhAcEiwAdj5dRnY3WAKMPtIu2aNUS7q8B-gFNclweAQbi3qBjAM19Kua6P_-iN5XzBoCKk0QAvD_BwE

https://www.chase.com/personal/investments/learning-and-insights/article/what-is-a-spac

Michael Burry’s Chart Tweet is Worth Understanding

Posted on by phoffman@channelchek.com
M. Burry – Cassandra B.C. (Twitter)

To Show Banks at Risk, Michael Burry’s Picture Equals 1000 Words

Michael Burry has a well-deserved reputation for foreseeing approaching crises and positioning his hedge funds to benefit client investors. While he’s most famous for his unique windfall leading to and after the mortgage crisis of 2008-2009, the current banking debacle has him tweeting thoughts most days. His most recent bank-related tweet is worth sharing and, for most investors, needs some explaining.  

Recently Burry posted a chart of some large banks and their insured deposit base relative to their Tier 1 capital.

@michaeljburry (Twitter)

Common Equity Tier 1 Capital (CET1)

To best understand this chart it helps to be aware that for U.S. banks, the definition of Tier 1 capital is set by regulators. It’s an apples to apples measure of a banks’ financial strength and easily used to compare bank peers.  Overall it is the bank’s core capital, and helps to understand how well the banks financial infrastructure can absorb losses. It includes equity and retained earnings, as well as certain other qualifying financial instruments.

 

Unrealized Bank Losses

The sub-prime banking crisis of 2008 is different than what banks are struggling with now. The problem then was created by lax lending practices, including liar loans, floating rate mortgages with teaser rates, significant house flipping using these introductory (teaser) first year rates, and repackaging and selling the debt – often to other banks.

The current issue facing banks today is the prolonged period of rates being held down by monetary policy. Low rates makes for easy money and economic growth, but there is eventually a cost. The cost is overstimulus and inflation, then what is needed to fight inflation, in other words, higher rates.

Higher rates hurt banks in a number of ways. The most calculable is the value of their asssets, including publicly traded fixed rate obligations (Treasuries, MBS, municipal bonds, corporate bonds, other bank marketable CDs) all decline in worth when rates rise. The other way banks get hurt is that loans extend out when rates rise by a significant amount. As a bank customer, this is easy to understand, if you took out a 30-year mortgage two years ago, your rate is between 2.75%-3.50%. If mortgage rates move, as they did to 7%, the prepayment speeds on the loans extend out farther. That is to say fewer borrowers are going to add more to their principal payment each month, and those that may have bought another residence by selling the first and paying the loan off, are staying put. The banks had assigned a historic expected prepayment speed to each loan that represents their region, and the low rate loans are now going to take much longer to repay.

FDIC Insurance

Michael Burry (on assets as described above) used his Bloomberg to chart large bank unrealized losses to the potential for depositors to remove their uninsured deposits. Currently the FDIC is only obligated to insure bank deposits up to $250,000. Customers with deposits in excess of this amount (depending on how registered) leave their excess money at a single bank at their own risk.

It would seem logical for large customers and small, in this environment to check their own risk and bring it to zero.

The Wisdom of the Chart

The further up and to the right banks are on the chart, the more at risk the bank can be considered. This is because uninsured deposits equal more than 60% of liabilities, so prudent customers would move someplace where they are better protected.

However, if depositors do move money out of the banks listed here, the bank would have to either find new deposits, or stand to lose 30% or more by selling assets that are underwater because of rising rates. The banks are currently not easily able to go out into the market and attract money. Partially because we are now in a climate where even basic T-Bill levels would be high for a bank to pay, but also because there is less money supply (M2) in the system.

@michaeljburry (Twitter)

Take Away

Michael Burry is a worth paying attention to. His communication is often through Twitter, and his tweets are often cryptic without context. His most recent set of tweets, including one commenting on the chart outlines what is happening with a number of banks that find themselves in the unenviable position of ignoring the Fed’s forward guidance on rates and very public inflation data.

Sign-up for free stories daily from Channelchek, along with research and a full calendar of investor events. Sign up here.

Paul Hoffman

Managing Editor, Channelchek

Sources

Cassandra B.C. on Twitter

The FOMC’s March Meeting Considerations

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

Will Systemic Risks to the Banking System Override Inflation Concerns When the Fed Meets?

Yes, the Federal Reserve’s central objective is to help maintain a sound banking system in the United States. The Fed’s regional presidents are currently in a blackout period (no public appearances) until after the FOMC meeting ends on March 22. So there is little for markets to go on to determine if the difficulties being experienced by banks will hinder the Fed’s resolve to bring inflation down to 2%. Or if the systemic risks to banks will override concerns surrounding inflation. Below we discuss some of the considerations the Fed may consider at the next meeting.

The Federal Reserve’s sound banking system responsibility is part of its broader responsibility to promote financial stability in the U.S. economy. The Fed does its best to balance competing challenges through monetary policy to promote price stability (low-inflation), maintaining the safety and soundness of individual banks, and supervising and regulating the overall banking industry to ensure that it operates in a prudent and sound manner.

While the headline news after the Fed adjusts monetary policy is usually about the Fed Funds target, the Fed can also adjust Reserve Requirements for banks. Along with that, the rate paid on these reserves, Interest on Excess Reserves (IOER). Another key bank rate that is mostly invisible to consumers is the Discount Rate. This is the interest rate at which banks can borrow money directly from the Federal Reserve. The discount rate is set by the Fed’s Board of Governors and is typically higher than the Federal Funds rate.

Banks try to avoid going to the Discount Window at the Fed because using this more expensive money is a sign to investors or depositors that something may be unhealthy at the institution. Figures for banks using this facility are reported each Thursday afternoon. There doesn’t seem to be bright flashing warning signs in the March 9 report. The amount lent on average for the seven-day period ending Thursday March 9, had decreased substantially, following a decrease the prior week. While use of the Discount Window facility is just one indicator of the overall banking systems health, it is not sending up red flags for the Fed or other stakeholders.

The European Central Bank Raised Rates

There is an expression, “when America sneezes, the world catches a cold.” The actions of the central bank in Europe, (the equivalent of the Federal Reserve in the U.S.) demonstrates that the bank failures in the U.S. are viewed as less than a sneeze. The ECB raised interest rates by half of a percentage point on Thursday (March 16). This is in line with its previously stated plan, even as the U.S. worries surrounding the banking system have shaken confidence in banks and the financial markets in recent days.

The ECB didn’t completely ignore the noise across the Atlantic; it said in a statement that its policymakers were “monitoring current market tensions closely” and the bank “stands ready to respond as necessary to preserve price stability and financial stability in the euro area.”

While Fed Chair Powell is restricted from making public addresses during the pre-FOMC blackout period, it is highly likely that there have been conversations with his cohorts in Frankfurt.

The Fed’s Upcoming Decision

On March 14, the Bureau of Labor Statistics (BLS) reported core inflation (without volatile food and energy) rose in February. Another indicator, the most recent PCE index released on February 24 also demonstrated that core prices are rising at a pace faster than the Fed deems healthy for consumers, banking, or the economy at large. The inflation numbers suggest it would be perilous for the Fed to pause its tightening efforts now.

What has so far been limited to a few U.S. banks is not likely to have been a complete surprise to those that have been setting monetary policy for the last 12 months. It may have surprised most market participants, but warning signs are usually picked up by the FRS, FDIC, and even OCC well in advance. And before news of a bank closure becomes public. Yet, the FOMC continued raising rates and implementing quantitative tightening. The big difference today is, the world is now aware of the problems and the markets are spooked.

The post-meeting FOMC statement will likely differ vastly from the past few meetings. While what the Fed decides to do remains far from certain, what is certain is that inflation is still a problem, and rising interest rates mathematically erode the value of bank assets. At the same time, money supply (M2) is declining at its fastest rate in history.  At its most basic definition, M2 is consumer’s cash position, including held at banks. As less cash is held at banks, some institutions may find themselves in the position SVB was in; they have to sell assets to meet withdrawals. The asset values, which were “purchased” at lower rates, now sell for far less than were paid for them.

This would seem to put the Fed in a box. However, if it uses the Discount Window tool, and makes borrowing easier by banks, it may be able to satisfy both demands. Tighter monetary policy, while providing liquidity to banks that are being squeezed.

Take Away

What the Fed will ultimately do remains far from certain. And a lot can happen in a week. Bank closings occur on Friday’s so the FDIC has the weekend to seize control. So if you’re concerned, don’t take Friday afternoons off.

If the Fed Declines to raise rates in March it could send a signal that the Fed is weakening its fight against inflation. This could cause rates to spike higher in anticipation of rising inflation. Everyone loses if that is the case, consumers, banks, and those holding U.S. dollars.

The weakness appears to be isolated in the regional-bank sector and was likely known to the Fed prior to the closing of the banks.

Consider this, only two things have changed for Powell since the last meeting, one is rising core CPI. The other is that he will have to do an even better job at building confidence post-FOMC meeting. Business people and investors want to know that the Fed can handle the hiccups along the path to stamping out high inflation.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/releases/h41/20230309/

https://www.bls.gov/news.release/cpi.nr0.htm

What Investors Should Note About SVB’s Loss

Posted on by phoffman@channelchek.com
Image Credit: Joe Shlabotnick (Flickr)

The SVB Loss Demonstrates A Risk Investors Should Pay Attention To

Individual investors and even some institutional money managers are reminded of a helpful truth from the Silicon Valley Bank (SVB) balance sheet problem. The reminder of the investment risk stands in conflict with what many top firms have been recommending to investors. So it should be revisited because, unlike banks, individuals and wealth managers tend to have a wider variety of places to look for return.

Bank balance sheet management is tricky. I say this with some credibility. In August of 2008, I accepted a role as the Treasurer of a mid-sized bank just two weeks before Freddie Mac and Fannie Mae were placed into conservatorship, and three weeks before Lehman filed for bankruptcy. I was responsible for quickly finding solutions for a big potential balance sheet problem. It was a problem similar to SVB’s. Depositors at the bank were taking money out at a faster pace than bank investments, including loans cashflows, could cover. Money that had not been committed to loans were invested in low-risk investment-grade fixed-income securities. It was nerve-racking, at one point, I calculated if any two of the largest ten customers withdrew all of their funds, the bank would not have the ability to cover the withdrawal. The pain that SVB is faced with is not dissimilar.

SVB is a bank that serves many fledgling companies during a period when capital and investment in start-ups have weakened from the days of easier money just a couple of years ago. Banks make money by borrowing short from customers (demand deposits, checking, and CDs) and then lend long, presumably at a higher rate. Here they make the spread that a typical upward-sloping yield curve provides. The main risk is in maturity. What happens if your longer-term loans were made at Fed Funds plus 2.50% two years ago when average deposit costs were 0.20%, since today Fed Funds are 4.50%? Your loans are paying the bank less than the bank’s cost to fund them with short deposits. This is a risk that all banks manage – balance sheet risk.

As deposits ran off at SVB because of business conditions in Silicon Valley, the bank turned to its investment portfolio to fund withdrawals. Securities in a US bank portfolio, when purchased, are designated at the custodian, by the Treasurer, either “Trading” which in this department of the bank is rare, “Available for Sale,” which provides the treasury department the ability to sell if need be, but also requires the assets to be priced at market (this impacts the banks valuation), or “Hold to Maturity” where the fixed income securities appear on the balance sheet at cost.  

If the securities are designated at purchase “Hold to Maturity” and the bank finds itself needing to sell any “Hold to Maturity” security, all securities marked “Hold to Maturity” become what regulators call tainted. The entire portfolio also becomes designated “Available for Sale.” This decision could dramatically reduce the bank’s book value in cases when interest rates have risen and bond values have dropped.

In the case of SVB, its securities portfolio, designed to earn more than deposits, was marked “Available for Sale.” When they sold, the market values were in such a lower position, from just a year earlier, that they recognized a dramatic loss. A $1.8 billion dollar loss which prompted its shares to lose more than half their market price.

Self-Directed Investors and Money Managers Should Note

The SVB explanation above, wernt a long way to remind that bonds, including US Treasury Notes have prices that rise and fall. They are different than equities, but price risk is real, and the $1.8 billion loss SVB recognized is front page proof. But since the beginning of the year many top-tier investment firms have recommended investors increase these fixed income investments and capture the new higher yields. Some even suggested ETFs in mortgaged-backed securities (MBS) or emerging markets (EM).

Goldman Asset Management is just one of the respected firms that have loudly suggested fixed income investments (CNBC, February 7, 2023)

Bond prices fall as rates rise. The Chair of the Federal Reserve, the same person that had orchestrated near zero rates, has clearly stated that the Fed will continue orchestrating higher rates. So while the stock market has been unattractive over the past 14 months, so have bonds. The difference, of course, is that bond math is absolute. As rates rise, the present value of any fixed-income security is calculated by the future value of future cash flow – this more or less determines the bonds price movement. For example,  if an investor buys a bond that yields 3%, and later rates go to 6% for the same maturity, the present value is about halved. This is a plausible scenario currently, with inflation near 6%.

Stock indexes have taken a beating over the past 14 months, just like bonds. The difference is rising rates sink all bonds. It doesn’t sink all stocks.

So while the S&P 500 is down 17% since January 1, 2022, and the Russell 2000 small-cap index is down 20%, one doesn’t even have to get out of the A’s to find AT&T (T) is up 4.15% in the same period, and Canadian Company Alvopetro (ALVOF) is up 43.6%). You won’t find this type of disparity in performance or direction on the fixed-income side. US Treasuries were down 10.5% for the period.

So from one perspective, stock selection may provide potential upside, whereas rising rates could mathematically sink all bond portfolio holdings.

Take Away

Silicon Valley Bank is in a unique situation as its customer base is not very diversified. The challenges they face may be similar to other banks, but this does not appear indicative of the whole sector based on recent stress tests. Banks are restricted in what they can invest in, with rates having risen, and promised to rise more, fixed-income holdings are at a loss in many portfolios, SVB’s need to raise cash caused them to recognize what was already a market loss.

Investors, however, can take a lesson from the loss the bank took. While I have seen articles this year suggesting capitalizing on higher interest rates, the ten-year US Treasury Note is well below its historical average (40-yr. avg.+5.17% vs 3.73% today). And rates are not even returning a real rate of return relative to current and expected inflation. This would indicate a period of likely market losses on bond holdings put on today.

A Stock, or portfolio of stocks, of course, may also present losses, but the odds that any particular stock, or even an index, would seem less certain than bonds.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.gsam.com/content/gsam/us/en/advisors/market-insights/gsam-insights/2022/1q2023-fixed-income-outlook.html#section-#policy

https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp

https://app.koyfin.com/share/c85b10bfc6

https://www.federalreserve.gov/supervisionreg/dfa-stress-tests-2022.htm

https://fred.stlouisfed.org/series/WGS10YR

Budget Discussions Likely to Roil Markets

Posted on by phoffman@channelchek.com
Image: Director of the Office of Management and Budget Shalanda Young besides President Biden (Credit: The White House, March 2022)

Investor Buy/Sell Patterns Could Change Under Biden Budget Proposals

The White House’s annual budget request to Congress has the power to move market sectors, as it’s a preliminary look at spending priorities and possible revenue sources. This year, alongside the pressure of Congress wrestling with raising the debt limit, the House Ways and Means Committee hearings related to the President’s budget could have a more significant impact than before. Treasury Secretary Janet Yellen will address the House committee on Friday, March 10th, and respond to questions. Taxation and spending priorities of the White House will be further revealed during this exchange.

Watch Live coverage at 9 AM ET.    

What is Expected

The President’s proposed budget for the 2024 fiscal year proposes cutting the U.S. deficit “by nearly $3 trillion over the next decade,” according to White House Press Secretary Karine Jean-Pierre, this is a much larger number than the $2 trillion mentioned as a goal during the State of the Union address last month. Jean-Pierre explained to reporters that the proposed spending reduction is “something that shows the American people that we take this very seriously,” and it answers, “how do we move forward, not just for Americans today but for … other generations that are going to be coming behind us.”

Source: Twitter

Biden’s requested budget includes a proposal that could impact healthcare as it would grow Medicare financing by raising the Medicare tax rate on earned and investment income to 5% from the current 3.8% for people making more than $400,000 a year.

Railroad safety measures are also included in Biden’s proposal, it asks for millions of additional funding for railroad safety measures spurred by recent derailments. The President also proposes a 5.2% pay raise for federal employees.

The budget deficit would be expected to shrink over ten years in part by raising taxes. One proposal investors should look out for is what has been called the Billionaire Minimum Income Tax. According to a White House brief, it “will ensure that the wealthiest Americans pay a tax rate of at least 20 percent on their full income, including unrealized appreciation. This minimum tax would make sure that the wealthiest Americans no longer pay a tax rate lower than teachers and firefighters.” The tax will apply only to the top 0.01% of American households (those worth over $100 million).

At present, the tax system discourages taking taxable gains on investments to postpone taxes. If adopted by Congress, a 20% tax on the unrealized appreciation of investments could have the effect of altering buying and selling patterns of securities, as well as real estate and other investments.

Jean-Pierre did say that the budget would propose “tax reforms to ensure the wealthy and large corporations pay their fair share while cutting wasteful spending on special interests like big oil and big pharma.” One reform, the White House has been outspoken about is corporate buybacks. He proposes, quadrupling the tax on corporate stock buybacks.

Take Away

The market will get insight beginning the second week of March 2023 into the financial priorities of the White House and thoughts on members of the House Ways and Means Committee. While nothing is set in stone, the White House and Congress would both seem to be on the same side of more fiscal restraint.

And although nothing is close to complete, the discussions and news of debate can have a dramatic impact on markets. For example, investors may be treated to more buybacks if it appears the tax on buybacks will increase in 2024. Another example would be a tax on the appreciated investments of wealthy individuals. It could follow that accounts of these individuals would have an increased incentive to transact than under a system where capital gains are only recognized by the IRS after taken.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.whitehouse.gov/briefing-room/press-briefings/2023/03/08/press-briefing-by-press-secretary-karine-jean-pierre-19/

https://www.whitehouse.gov/omb/

https://www.congress.gov/event/118th-congress/house-event/115464?s=1&r=6

https://fortune.com/2023/02/10/how-much-would-musk-gates-bezos-pay-bidens-billionaire-tax/

What to Look for in a Biotech Stock

Posted on by phoffman@channelchek.com
Image Credit: Marco Verch (Flickr)

Steps to Discover Which Biotech Stocks May Get Hot

The biotech sector is in and of itself exciting. A company developing an idea that can improve human lives, decrease suffering, or even prevent death, by nature, could be a more rewarding endeavor than investing in a company that, by comparison, does little to make a big difference. If, at the same time, the opportunity to return the investor a multiple over returns available elsewhere in the market, then the motivation to allocate a portion of investment capital increases dramatically. But how does an investor gauge a company in the biotech sector and evaluate its chance of survival and likelihood of success?

As with much of investing, sure things don’t often provide a good return. And adding risk doesn’t necessarily equate to added return. The higher perceived risk of a sector such as biotech needs to be offset by research. Filtering stocks through a selection process is key, so the probability of picking those that survive and thrive is higher than average.

I spoke with Robert LeBoyer, the Senior Life Sciences Analyst at Noble Capital Markets, and asked him to list factors to improve the likelihood of choosing a successful biotech company. His knowledge and enthusiasm for the sector caused me to want to share what I learned.

Differentiation

Companies developing a drug that is different than all that came before for what it proposes to treat or prevent stand a good chance of getting funding to make it through the different phases of study. With a development time of 3-5 years, it is best if there is a clear unmet need for the therapy or no current therapies at all.

Investors should determine if there are treatments presently and ask whether the drug or treatment mechanism is a significant improvement over any current product. Also is the field crowded or will it soon be crowded with alternatives to what a company may bring to market? LeBoyer recommended asking where there is an improvement. He gave the example of many cholesterol-lowering drugs, which he said all target the same enzyme. A company with a drug that similarly targets that enzyme may not be worth exploring. Learning of a company that has a different mechanism of action, one which shows promise of greater efficacy, or, reduced cost, or fewer side effects may be worth exploring further.

As an example of a company that had met these criteria some years back, Gilead received approval for a once-daily tablet to treat hepatitis C. Prior to this, the only treatment options involved a year-long regimen of weekly interferon injections and ribavirin tablets. The side effects were depression, nausea, flu-like symptoms, and a reduction in some blood cells. The cost of the injections and treatments could cost a health insurer $1 million over the life of the patient. The Gilead treatment, which has a price tag of $93,000, is mathematically more cost-effective. The therapy which Gilead got approved in the U.S. in 2013 was a better treatment than what existed, and even better tolerated by patients. The stock went from $20 to $120 in about a years time after approval.

Development

Clinical development was another attribute brought up by Noble’s analyst. With even the best proof of concept or early-stage trial success, assessing the chance that clinical stage trials may fail for pipeline candidates is difficult.  This is why a company with a diverse pipeline with a number of products being developed or in later stages of clinical trials, increases the probability of successful biotech investment. Many companies easily pass stage one trials and even stage two, but don’t get past the final hurdle. LeBoyer shared with me a story of a company he now covers that had a vaccine for Covid-19 early on. The human clinical trials, however, were not done in the U.S., but were instead the result of trials on persons mostly of similar lineage. The FDA required a sampling comparable to the diversification of heritage or gene pool in the U.S.  

Obtaining a basic understanding of the FDA side of development is important for anyone making decisions on biotech stocks.

The drug approval process in the U.S. involves multi-layered (Step One through Step Four) with each representing an important milestone on the path to full approval so the product can be brought to market or meet rejection along the path.

Step One is the development phase, Step Two is research, Step Three is Clinical Trials, and Step Four is FDA Approval.

Knowing where companies stands in the FDA step process can help an investor assess the likelihood of approval. Many products, can get to the last step and not be approved, but those just starting out on Step One are a greater risk both in the time it will take and the chance for something to not be to the FDA’s liking.

Finances

Biotech companies, by and large burn through cash in their research, development and trial periods. Understanding how long the cash on hand and other available sources can last before they need to raise more cash, then comparing this with how close to an expected finish line they are, could help an investor steer away from a company that may have a product in the pipeline that meets other key elements investors should look at, but unfortunately, funds may stand in the way of success.

Robert LeBoyer explained that the current high-interest rate environment, coupled with depressed stock prices, makes this particularly important now. For those companies that can borrow, the cost of money is now far more expensive than it had been in the last decade and a half. And issuing more shares, essentially selling more of the company, dilutes the value of shares currently held. It could become a tricky situation that stockholders or those deciding to become a stockholder should monitor

Take Away

Are there companies with a pipeline that includes drugs that meet a large unmet need (as one example, Alzheimer’s), or can attack a disease like cancer in a unique way that would be embraced by the medical community and patients? “Unicorn” companies do exist, but finding them, assessing them, and doing it before a louder investment buzz occurs takes some digging. A solid place to start digging is under the biotech company section on Channelchek.  Available by clicking here, here investors are exposed to many opportunities and the underlying data, the latest news, and of course, thorough company descriptions.

Biotech companies covered by analyst Robert LeBoyer, along with his current research are available here. Channelchek will be highlighting interesting biotechs in future articles and discussing their work and status against the criteria presented above. Join Channelchek to receive emails and gain free access to these articles, video presentations, updated research reports, and news of company roadshows. Visit Rob LeBoyers coverage list here.

Paul Hoffman

Managing Editor, Channelchek

Powell’s Testimony to Congress Revealed A Lot

Posted on by phoffman@channelchek.com
Image Credit: C-Span (YouTube)

Is the Fed Doing Too Much, Not Enough, or Just Right?

The Fed Reserve Chair Jerome Powell has an ongoing credibility problem. The problem is that markets, economists, and now Congress find him extremely credible. So credible that they have already declared him a winner fighting inflation, or of more pertinence, the economy a loser because Powell and the Fed policymakers have been so resolute in their fight against the rising cost of goods and services that soon there will be an abundance of newly unemployed, businesses will falter, and the stock market will be left in tatters. This view that he has already done too much and that the economy has been overkilled, even while it shows remarkable strength, was echoed many times during his visit to Capital Hill for his twice a year testimony.

“As of the end of December, there were 1.9 job openings for each unemployed individual, close to the all-time peak recorded last March, while unemployment insurance claims have remained near historic lows.” – Federal Reserve Chair Jay Powell (March 8, 2023).

Powell’s Address

Perhaps the most influential individual on financial markets in the U.S. and around the world, Fed Chair Powell continued his hawkish (inflation fighter, interest rate hiker) tone at his Senate and House testimonies. The overall message was; inflation is bad, inflation has been persistent, we will continue on the path to bring it down, also employment is incredibly strong, the employment situation is such that we can do more, we will do more to protect the U.S. economy from the ravages of inflation.

Powell began, “My colleagues and I are acutely aware that high inflation is causing significant hardship, and we are strongly committed to returning inflation to our 2 percent goal.” Powell discussed the forceful actions taken to date and added, “we have more work to do. Our policy actions are guided by our dual mandate to promote maximum employment and stable prices. Without price stability, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of labor market conditions that benefit all.”

Powell discussed the slowed growth last year; there were two periods of negative GDP growth reported during the first two quarters. He mentioned how the once red-hot housing sector is weakening under higher interest rates and that “Higher interest rates and slower output growth also appear to be weighing on business fixed investment.” He then discussed the impact on labor markets, “Despite the slowdown in growth, the labor market remains extremely tight. The unemployment rate was 3.4 percent in January, its lowest level since 1969. Job gains remained very strong in January, while the supply of labor has continued to lag.1 As of the end of December, there were 1.9 job openings for each unemployed individual, close to the all-time peak recorded last March, while unemployment insurance claims have remained near historic lows.”

On the subject of monetary policy, the head of the Federal Reserve mentioned that the target of 2% inflation has not been met and that recent numbers have it moving in the wrong direction. Powell also discussed that the Fed had raised short-term interest rates by adding 4.50%. He suggested that recent economic numbers require that an increase to where the sufficient height of fed funds peaks is likely higher than previously thought. All the while, he added, “we are continuing the process of significantly reducing the size of our balance sheet.”

Powell acknowledged some headway, “We are seeing the effects of our policy actions on demand in the most interest-sensitive sectors of the economy. It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation. In light of the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity and inflation, the Committee slowed the pace of interest rate increases over its past two meetings.” Powell added, “We will continue to make our decisions meeting by meeting, taking into account the totality of incoming data and their implications for the outlook for economic activity and inflation.”

Questions and Answers

Congressmen both in the Senate and the House use the Semiannual Monetary Policy Report to Congress (formerly known as Humphrey Hawkins Testimony) to ask questions of the person with the most economic insight in Washington. Often their questions have already been covered in the Chair’s opening address, but Congresspeople will ask anyway to show their constituents at home that they are looking after them.

Elizabeth Warren is on the Senate Banking Committee; her math concluded the result of even a 1% increase in unemployment is a two million-worker job loss. Warren asked Powell, “Do you call laying off two million people this year not a sharp increase in unemployment?” “Explain that to the two million families who are going to be out of work.” In his response, Powell went back to historical numbers and reminded the Senator that an increase in unemployment would still rank the current economy above what Americans have lived through in most of our lifetimes, “We’re not, again, we’re not targeting any of that. But I would say even 4.5 percent unemployment is well better than most of the time for the last, you know, 75 years,” Chair Powell answered.

U.S. House Financial Services Committee on Wednesday heard Congressman Frank Lucas concerned about the pressure for the Fed to include climate concerns as an additional Fed mandate. Lucas from Oklahoma asked,  “How careful are you in ensuring that the Fed does not place itself into the climate debate, and how can Congress ensure that the Fed’s regulatory tool kit is not warped into creating policy outcomes?” Powell answered that the Fed has a narrow but real role involving bank supervision. It’s important that individual banks understand and can manage over time their risks from any climate change and it’s impact on business and the economy. He wants to make sure the Fed never assumes a role where they are becoming a climate policymaker.

Other non-policy questions included Central Bank Digital Currencies. House Congressman Steven Lynch showed concerns that the Fed was experimenting with digital currencies. His question concerned receiving a public update on where they are with their partnership with MIT, their testing, and what they are trying to accomplish. Powell’s response seemed to satisfy the Congressman. “we engage with the public on an ongoing basis, we are also doing research on policy, and also technology,” said Powell. Follow-up questions on the architecture of a CBDC, were met with responses that indicated that the Fed, they are not at the stage of making decisions, instead, they are experimenting and learning. “How would this work, does it work, what is the best technology, what’s the most efficient.” Powell emphasized that the U.S. Federal Reserve is at an early stage, but making technological progress. They have not decided from a policy perspective if this is something that the country needs or desires.

Issues at Stake

As it relates to the stock and bond markets, the Fed has been holding overnight interest rates at a level that is more than one percentage point below the rate of inflation. The reality of this situation is that investors and savers that are earning near the Fed Funds rate on their deposits are losing buying power to the erosive effects of inflation. Those that are investing farther out on the yield curve are earning even less than overnight money. The impact here could be worse if inflation remains at current levels or higher, or better if the locked-in yields out longer on the curve are met with inflation coming down early on.

The Fed Chair indicated at the two testimony before both Houses of Congress that inflation has been surprisingly sticky. He also indicated that they might increase their expected stopping point on tightening credit. Interest rates out in the periods are actually lower than they had been in recent days and as much as 0.25% lower than they were last Fall. The lower market rates and inverted yield curve suggest the market thinks the Fed has already won and has likely gone too far. This thought process has made it difficult for the Fed Chair and others at the Fed that discuss a further need to throw cold water on an overheated economy. Fed Tightening has not led to an equal amount of upward movement out on the yield curve. This trust or expectation that the Fed has inflation under control would seem to be undermining the Fed’s efforts. With this, the Fed is likely to have to move even further to get the reaction it desires. The risk of an unwanted negative impact on the economy is heightened by the trust the bond market gives to Powell that he has this under control and may have already won.

Powell’s words are that the Fed has lost ground and has much more work to do.

Take Away

At his semiannual testimony to Congress, an important message was sent to the markets. The Fed has the right tools to do the job of bringing inflation down to the 2% range, but those tools operate on the demand side. In the U.S. we are fortunate to have two jobs open for every person seeking employment. While this is inflationary, it provides policy with more options.

As of the reporting of January economic numbers, a trend may be beginning indicating the Fed is losing its fight against inflation. It is likely that it will have to do more, but the Fed stands willing to do what it takes. Powell ended his prepared address by saying, “Everything we do is in service to our public mission. We at the Federal Reserve will do everything we can to achieve our maximum-employment and price-stability goals.”

Paul Hoffman

Managing Director, Channelchek

Sources

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

Big Tech Trying to Act More Like Nimble Smaller Companies

Posted on by phoffman@channelchek.com
Image Credit: Book Catalog (Flickr)

Why Meta’s Embrace of a ‘Flat’ Management Structure May Not Lead to the Innovation and Efficiency Mark Zuckerberg Seeks

Big Tech, under pressure from dwindling profits and falling stock prices, is seeking some of that old startup magic.

Meta, the parent of Facebook, recently became the latest of the industry’s dominant players to lay off thousands of employees, particularly middle managers, in an effort to return to a flatter, more nimble organization – a structure more typical when a company is very young or very small.

Meta CEO Mark Zuckerberg joins Elon Musk and other business leaders in betting that eliminating layers of management will boost profits. But is flatter better? Will getting rid of managers improve organizational efficiency and the bottom line?

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 ofAmber Stephenson, Associate Professor of Management and Director of Healthcare Management Programs, Clarkson University.

As someone who has studied and taught organization theory as well as leadership and organizational behavior for nearly a decade, I think it’s not that simple.

Resilient Bureaucracies

Since the 1800s, management scholars have sought to understand how organizational structure influences productivity. Most early scholars focused on bureaucratic models that promised managerial authority, rational decision-making and efficiency, impartiality and fairness toward employees.

These centralized bureaucratic structures still reign supreme today. Most of us have likely worked in such organizations, with a boss at the top and clearly defined layers of management below. Rigid, written rules and policies dictate how work is done.

Research shows that some hierarchy correlates with commercial success – even in startups – because adding just one level of management helps prevent directionless exploration of ideas and damaging conflicts among staff. Bureaucracies, in their pure form, are viewed as the most efficient way to organize complex companies; they are reliable and predictable.

While adept at solving routine problems, such as coordinating work and executing plans, hierarchies do less well adapting to rapid changes, such as increased competition, shifting consumer tastes or new government regulations.

Bureaucratic hierarchies can stifle the development of employees and limit entrepreneurial initiative. They are slow and inept at tackling complex problems beyond the routine.

Moreover, they are thought to be very costly. Management scholars Gary Hamel and Michele Zanini estimated in 2016 that waste, rigidity and resistance to change in bureaucratic structures cost the U.S. economy US$3 trillion in lost output a year. That is the equivalent of about 17% of all goods and services produced by the U.S. economy at the time of the study.

Even with the mounting criticisms, bureaucratic structures have shown resilience over time. “The formal managerial hierarchy in modern organizations is as persistent as are calls for its replacement,” Harvard scholars Michael Lee and Amy Edmondson wrote in 2017.

Fascinatingly Flat

Flat structures, on the other hand, aim to decentralize authority by reducing or eliminating hierarchy. The structure is harnessed to flexibility and agility rather than efficiency, which is why flat organizations adapt better to dynamic and changing environments.

Flat structures vary. Online retailer Zappos, for example, adopted one of the most extreme versions of the flat structure – known as holacracy – when it eliminated all managers in 2014. Computer game company Valve has a president but no formal managerial structure, leaving employees free to work on projects they choose.

Other companies, such as Gore Tex maker W. L. Gore & Associates and film-streaming service Netflix, have instituted structures that empower employees with wide-reaching autonomy but still allow for some degree of management.

In general, flat structures rely on constant communication, decentralized decision-making and the self-motivation of employees. As a result, flat structures are associated with innovation, creativity, speed, resilience and improved employee morale.

The promises of going flat are understandably enticing, but flat organizations are tricky to get right.

The list of companies succeeding with flat structures is noticeably short. Besides the companies mentioned above, the list typically includes social media marketing organization Buffer, online publisher Medium and tomato processing and packing company Morning Star Tomatoes.

Other organizations that attempted flatter structures have encountered conflicts between staff, ambiguity around job roles and the emergence of unofficial hierarchies – which undermines the whole point of going flat. They eventually reverted back to hierarchical structures.

“While people may lament the proliferation of red tape,” management scholars Pedro Monteiro and Paul Adler explain, “in the next breath, many complain that ‘there ought to be a rule.’”

Even Zappos, often cited as the case study for flat organizations, has slowly added back managers in recent years.

Right Tool

In many ways, flat organizations require even stronger management than hierarchical ones.

When managers are removed, the span of control for those remaining increases. Corporate leaders must delegate – and track – tasks across greater numbers of employees and constantly communicate with workers.

Careful planning is needed to determine how work is organized, information shared, conflicts resolved and employees compensated, hired and reviewed. It is not surprising that as companies grow, the complexity of bigger organizations poses barriers to flat models.

In the end, organizational structure is a tool. History shows that business and economic conditions determine which type of structure works for an organization at any given time.

All organizations navigate the trade-off between stability and flexibility. While a hospital system facing extensive regulations and patient safety protocols may require a stable and consistent hierarchy, an online game developer in a competitive environment may need an organizational structure that’s more nimble so it can adapt to changes quickly.

Business and economic conditions are changing for Big Tech, as digital advertising declines, new competitors surface and emerging technologies demand risky investments. Meta’s corporate flattening is one response.

As Zuckerberg noted when explaining recent changes, “Our management theme for 2023 is the ‘Year of Efficiency,’ and we’re focused on becoming a stronger and more nimble organization.”

But context matters. So does planning. All the evidence I’ve seen indicates that embracing flatness by cutting middle management will not, by itself, do much to make a company more efficient.

Will Elon Musk Inspire and Excite on Investor Day 2023?

Posted on by phoffman@channelchek.com
Image Credit: Trubni (Instagram)

Will Tesla Investors be Inspired or Disappointed on March 1 (Investor Day)?

Tesla’s Investor Day is March 1st. The lead-up to these events is usually filled with speculation of how the founder, Elon Musk, may surprise EV fans and the investment community. Tesla’s (TSLA) innovations and unique marketing and distribution have made it the most valuable car company in the world. Part of that marketing is the mystique and confidence Musk brings whenever he has an audience. The company is also inspiring as it is less than 20 years in the making and is leading a revolution in how automobiles are built, driven, and fueled.

As plans are kept under wraps, most of the rumors as to what to expect fall in the category of speculation. Below are some of the most likely ideas from past announcements from Tesla and across the internet since the meeting date was announced.

Battery Production

Sourcing raw materials for batteries to make certain new EVs have all the needed components is becoming a concern among car manufacturers.

News has leaked of a proposed $3.6 billion Giga factory to produce up to 100 Gwh of batteries. The factory is expected to be in Nevada and eventually be used to assemble the Tesla semi when production eventually starts.

Tesla is expected to build a processing facility to make lithium hydroxide from spodumene concentrate in Corpus Christie, Texas. The location is good for shipping, and it is close to sources of sulfuric acid from the oil industry. This would be the first lithium hydroxide production facility in the U.S. If true, it would help Tesla fulfill the raw material sourcing requirements of the Inflation Reduction Act to qualify its cars for the $7,500 federal tax credit.

Those deals are at market prices; Tesla would reap the profits from processing the spodumene concentrate into hydroxide, but the bulk of the profit from the material supply accrues to the mining company. Tesla has hinted previously of plans to enter the lithium mining business.

The $25,000 EV

First mentioned in 2020, Tesla’s proposed $25,000 car earned the nickname “fluffy pillow” after Musk showed a picture of an object covered by a blanket that many thought resembled a large pillow. The project was put on hold in early 2022 when Musk said Tesla had too much on its plate.

Tesla’s existing best sellers, the Model 3 and Model Y, have been around for a while, a new model, whether it is the truck or an affordable entry level car would freshen up the line-up.

New Factory

Tesla’s production goals put it at or near capacity. The current factory capacity is listed as 1.9 million vehicles per year. The current goal is six million cars a year by 2026. This would require the expansion of existing plants and then some. A new factory takes three years to design, construct, and get rolling. So planning would have to start now. Musk is more likely to build a new plant than change his production goals.

Thoughts from across the internet suggest this could be in Indonesia or Mexico. Cars built in Mexico could qualify for the $7500 tax credit to purchasers.

Capital Raise

To accomplish the above requires money. Currently, there is construction in progress building out Tesla’s German and Texas factories. Billions more would be needed to implement other plans.

There is as of recent reporting, $22 billion in cash on Tesla’s balance sheet. This is a snapshot of quarter-end and not an accurate representation of the company’s finances. Offsetting this large number is $15 billion in trade payables and $7 billion in accrued payables, much of which is due soon.

Tesla may have to go to the market to raise cash for projects that will be presented on March 1st.

About Tesla Day

The investor event will be live-streamed from Tesla’s Gigafactory in Texas, with some of the company’s institutional and retail investors attending in person. According to Tesla’s press release, investors will be able to see its most advanced production line as well as discuss long-term expansion plans, the generation 3 platform, and capital allocation.  

Paul Hoffman

Managing Editor, Channelchek

Sources

https://ir.tesla.com/press-release/tesla-announces-date-2023-investor-day

https://www.whitehouse.gov/briefing-room/statements-releases/2022/09/14/fact-sheet-president-bidens-economic-plan-drives-americas-electric-vehicle-manufacturing-boom/

https://www.barrons.com/articles/tesla-cars-brand-rank-51674047645

AI and the U.S. Military’s Unmanned Technological Edge

Posted on by phoffman@channelchek.com
Image: Marine Corps Warfighting Laboratory MAGTAF Integrated Experiment (MCWL) 160709-M-OB268-165.jpg

War in Ukraine Accelerates Global Drive Toward Killer Robots

The U.S. military is intensifying its commitment to the development and use of autonomous weapons, as confirmed by an update to a Department of Defense directive. The update, released Jan. 25, 2023, is the first in a decade to focus on artificial intelligence autonomous weapons. It follows a related implementation plan released by NATO on Oct. 13, 2022, that is aimed at preserving the alliance’s “technological edge” in what are sometimes called “killer robots.”

Both announcements reflect a crucial lesson militaries around the world have learned from recent combat operations in Ukraine and Nagorno-Karabakh: Weaponized artificial intelligence is the future of warfare.

“We know that commanders are seeing a military value in loitering munitions in Ukraine,” Richard Moyes, director of Article 36, a humanitarian organization focused on reducing harm from weapons, told me in an interview. These weapons, which are a cross between a bomb and a drone, can hover for extended periods while waiting for a target. For now, such semi-autonomous missiles are generally being operated with significant human control over key decisions, he said.

Pressure of War

But as casualties mount in Ukraine, so does the pressure to achieve decisive battlefield advantages with fully autonomous weapons – robots that can choose, hunt down and attack their targets all on their own, without needing any human supervision.

This month, a key Russian manufacturer announced plans to develop a new combat version of its Marker reconnaissance robot, an uncrewed ground vehicle, to augment existing forces in Ukraine. Fully autonomous drones are already being used to defend Ukrainian energy facilities from other drones. Wahid Nawabi, CEO of the U.S. defense contractor that manufactures the semi-autonomous Switchblade drone, said the technology is already within reach to convert these weapons to become fully autonomous.

Mykhailo Fedorov, Ukraine’s digital transformation minister, has argued that fully autonomous weapons are the war’s “logical and inevitable next step” and recently said that soldiers might see them on the battlefield in the next six months.

Proponents of fully autonomous weapons systems argue that the technology will keep soldiers out of harm’s way by keeping them off the battlefield. They will also allow for military decisions to be made at superhuman speed, allowing for radically improved defensive capabilities.

Currently, semi-autonomous weapons, like loitering munitions that track and detonate themselves on targets, require a “human in the loop.” They can recommend actions but require their operators to initiate them.

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, James Dawes, Professor, Macalester College.

By contrast, fully autonomous drones, like the so-called “drone hunters” now deployed in Ukraine, can track and disable incoming unmanned aerial vehicles day and night, with no need for operator intervention and faster than human-controlled weapons systems.

Calling for a Timeout

Critics like The Campaign to Stop Killer Robots have been advocating for more than a decade to ban research and development of autonomous weapons systems. They point to a future where autonomous weapons systems are designed specifically to target humans, not just vehicles, infrastructure and other weapons. They argue that wartime decisions over life and death must remain in human hands. Turning them over to an algorithm amounts to the ultimate form of digital dehumanization.

Together with Human Rights Watch, The Campaign to Stop Killer Robots argues that autonomous weapons systems lack the human judgment necessary to distinguish between civilians and legitimate military targets. They also lower the threshold to war by reducing the perceived risks, and they erode meaningful human control over what happens on the battlefield.

This composite image shows a ‘Switchblade’ loitering munition drone launching from a tube and extending its folded wings. U.S. Army AMRDEC Public Affairs

The organizations argue that the militaries investing most heavily in autonomous weapons systems, including the U.S., Russia, China, South Korea and the European Union, are launching the world into a costly and destabilizing new arms race. One consequence could be this dangerous new technology falling into the hands of terrorists and others outside of government control.

The updated Department of Defense directive tries to address some of the key concerns. It declares that the U.S. will use autonomous weapons systems with “appropriate levels of human judgment over the use of force.” Human Rights Watch issued a statement saying that the new directive fails to make clear what the phrase “appropriate level” means and doesn’t establish guidelines for who should determine it.

But as Gregory Allen, an expert from the national defense and international relations think tank Center for Strategic and International Studies, argues, this language establishes a lower threshold than the “meaningful human control” demanded by critics. The Defense Department’s wording, he points out, allows for the possibility that in certain cases, such as with surveillance aircraft, the level of human control considered appropriate “may be little to none.”

The updated directive also includes language promising ethical use of autonomous weapons systems, specifically by establishing a system of oversight for developing and employing the technology, and by insisting that the weapons will be used in accordance with existing international laws of war. But Article 36’s Moyes noted that international law currently does not provide an adequate framework for understanding, much less regulating, the concept of weapon autonomy.

The current legal framework does not make it clear, for instance, that commanders are responsible for understanding what will trigger the systems that they use, or that they must limit the area and time over which those systems will operate. “The danger is that there is not a bright line between where we are now and where we have accepted the unacceptable,” said Moyes.

Impossible Balance?

The Pentagon’s update demonstrates a simultaneous commitment to deploying autonomous weapons systems and to complying with international humanitarian law. How the U.S. will balance these commitments, and if such a balance is even possible, remains to be seen.

The International Committee of the Red Cross, the custodian of international humanitarian law, insists that the legal obligations of commanders and operators “cannot be transferred to a machine, algorithm or weapon system.” Right now, human beings are held responsible for protecting civilians and limiting combat damage by making sure the use of force is proportional to military objectives.

If and when artificially intelligent weapons are deployed on the battlefield, who should be held responsible when needless civilian deaths occur? There isn’t a clear answer to that very important question.

Lithium Stocks are Depressed, Might They Be a Buy?

Posted on by phoffman@channelchek.com
Image: Silver Peak Lithium Mine, Nevada – Ken Lund (Flickr)

The Lithium Dip May Be Worth Exploring

Lithium (Li) was once synonymous with treating depression. Today the mineral is more often discussed as part of the subject of sustainable energy storage, specifically batteries. So it’s ironic that the recent stock price movement of a number of companies tied to lithium may have depressed some investors, as February has seen a sudden depression in values. The primary reason for the decline in lithium stocks may actually be a net plus for miners and others tied to production. This thinking is outlined below.  

Many companies involved in Li exploration and/or production were up on the year along with the overall market. Late last week and carrying over to today, many of these stocks have fallen dramatically. The reason for the sudden decline coincided with the largest EV battery manufacturer, Contemporary Amperex Technology’s (CATL) announcement that it will cut the price it charges for Li-ion batteries.

As seen in the chart below, Shares of the larger lithium miners Albemarle ALB (ALB), SQM (SQM), Livent (LTHM), Piedmont Lithium (PLL), and Lithium Americas (LAC) are down between 7% and 14% with much of that drop coming in the past few trading days. Smaller lithium mining operations like LithiumBank Resources Corp. (LBNKF), and Century Lithium Corp. (CYDVF) fared much better, outperforming the more established larger companies.

Source: Koyfin

Did Traders Get this Wrong?

CATL seems to have aimed to maintain or grow its market share as a battery manufacturer. Any price war they may have started is likely to have a direct impact on competitors. Even car manufacturers that are involved in battery sales may shed some profitability, but is it necessarily a negative for companies involved in mining or refining?

CATL plans on pricing its batteries on a lithium-price-linked calculation. With this, 50% of each battery will benchmark to lithium carbonate, which would largely embed the price of lithium in its Li-ion product. The rest of the batteries will key off of the spot market for lithium carbonate.

Spot prices for lithium carbonate are up about ninefold over the past few years as the growth in EV demand and other battery-operated products has stressed the global lithium supply chain. So while CATL has decided to discount batteries, the production costs are unlikely to fall. The move may instead place greater demand on lithium carbonate. If production doesn’t keep up with, what should spark greater demand for Li-ion batteries, miners may benefit. If correct, this could suggest the declines in mining stock prices related to CATL’s new pricing policy, may be considered as an entry point for investors that had been looking for a price dip.

As for battery makers, this may have more permanently drained value. CATL is about 68% of the mainland Chinese EV battery manufacturing industry. Other battery producers may have to similarly adjust their pricing models to compete. This group includes Panasonic, LG Energy, Samsung, and SK Innovations that also tumbled this month.

Take Away

Mining analysts discuss supply and demand, or deficit and surplus, when adjusting forecasts. If demand grows as a result of the large battery manufacturer CATL discounting prices, and this discounting causes others to follow, the result could be a larger lithium deficit that could raise the price of the mineral per USD/metric-ton. Time will tell.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.uptodate.com/contents/unipolar-depression-in-adults-treatment-with-lithium/print#:~:text=In%20addition%2C%20lithium%20is%20used,mid%2D1800s%20%5B2%5D.

https://www.barrons.com/articles/lithium-stocks-tesla-ev-battery-shares-40aa53d0?mod=hp_columnists

https://www.barrons.com/articles/tesla-stock-price-graphite-battery-magnis-bc0dad59?mod=hp_LATEST

Choosing Investments While Government Spending Levels Grow

Posted on by phoffman@channelchek.com
Image: US Debt Clock in NYC

The US Budget Office Just Laid Out its Ten-Year Forecast – What Investors Should Know

The US National Debt Clock app might be useful for those that suffer from low blood pressure. I’m being facetious – the app and website provide a visual of the current estimated overall national debt. It breaks out what each citizen’s theoretical share is, and then divides it up in dozens f other categories. The clock is an estimate of real-time. For a future projection, the better place to turn is the just-released forecast from the Congressional Budget Office (CBO). The CBO’s website can be insightful and idea-provoking for investors as it includes a 10-year forecast for government spending, which is broken down by industry type.

Source: USdebtclock.org (February 17, 2023)

Direction of Overall US Debt

The US is on track to accumulate more than $19 trillion in additional debt over the next decade, according to a CBO document released on February 15.

This new expectation is $3 trillion more than previously forecast. Coming at a time when there is headbutting and chest pounding going on in Washington surrounding the debt ceiling (US Treasury borrowing cap), the significantly larger 10-year budget may additionally stress the governments ability to pay its bills. Phillip Swagel, a director at the CBO expressed his concern saying, “The warning is that the fiscal trajectory is unsustainable.”

The federal government is expected to collect $65 trillion in revenue over the next ten years. More than half is expected to come from individual income taxes, and another third comes from payroll taxes. Individually, we can’t change what may be higher taxes, or a weakened government financial situation, which, separate from the Federal Reserve, puts upward pressure on interest rate levels.

Source: CBO

Drilling down deeper into where the funding is expected to flow from, individual income taxes are planned to remain level through 2025, then ramp up at a pace quicker than payroll taxes and corporate taxes.

But the country will spend much more than what it collects. Rising interest payments, large federal stimulus bills, and the growing costs of Social Security and Medicare benefits for retiring baby boomers are some of the government’s largest spending items.

Source: CBO (Data excludes offsetting receipts)

Of the Federal agencies budgeted to spend the highest amount, health and human services top the list. Small percentage increases are a lot in actual dollar amounts when trillions are involved. Social Security is the agency consuming the second most amount, followed by the Treasury, which is experiencing growing interest expenses.

Source: CBO

Looking at a broader swath of areas that should benefit as a result of government budget expansion, we see in the graph above the top three areas already mentioned, followed by at least a trillion spent over ten years in defense, veterans affairs, agriculture, transportation, personnel, education, and homeland security.

For Investors to Think About

Short-term investors tend to ignore some approaching realities while overly focusing on others. Long-term, investors may find that the cost and expansion of public debt will eventually have the US responsible to pay more in interest over the next decade. By 2033, the net interest on public debt is expected to make up 14% of the federal government’s total spending.

There was another period in US history when net interest made up such a large slice of Federal spending, this was in the mid-to-late 1980s. Eventually, Congress did pay some attention to deficit reduction; it took years to taper the growth. The resurgence of the expanding debt trend in recent years has been explosive.

Interest rates on bonds could have built upward pressure as more debt would need to be issued to refinance at higher rates and pay for additional spending. A greater supply of debt without a growing supply of buyers is a recipe for higher bond yields. Are higher yields attractive? In bond markets, the value of a fixed bond goes down when rates rise. Floating rate bonds tend to approximate par throughout their life, but the Treasury and Wall Street have not been quick to issue these in the face of rising coupon rates.

Stock market investors may find value in investing in companies that receive 25% or more of their revenue from government contracts, particularly those agencies on the chart above that are budgeted to grow by billions or trillions. This could include smaller companies where the impact is greater. Within this category are aerospace contractors like Kratos (KTOS), communications companies like Comtech (CMTL), or transportation-related spending that could benefit dredging from companies like Great Lakes Dredge and Dock (GLDD).

The smaller companies mentioned may benefit from the massive budget growth. But they are not alone, Channelchek is a great source of data and discovery of many companies doing great things that are destined to become even greater. Be sure to sign-up for all the free resources available to investors by going here.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.cbo.gov/

https://www.cbo.gov/publication/58848

https://www.cbo.gov/data/budget-economic-data#11

https://www.cbo.gov/data/estimate-presidents-budget-proposals

https://www.usdebtclock.org/

Assessing Five Risks of the Rail Disaster in Ohio

Posted on by phoffman@channelchek.com
Source: EPA.gov

How Dangerous Was the Ohio Chemical Train Derailment? An Environmental Engineer Assesses the Long-Term Risks

State officials offered more details of the cleanup process and a timeline of the environmental disaster during a news conference on Feb. 14, 2023. Nearly a dozen cars carrying chemicals, including vinyl chloride, a carcinogen, derailed on the evening of Feb. 3, and fire from the site sent up acrid black smoke. Officials said they were testing over 400 nearby homes for contamination and tracking a plume of spilled chemicals that had killed 3,500 fish in streams and reached the Ohio River.

However, the slow release of information after the derailment has left many questions unanswered about the risks and longer-term impact. We discussed the chemical release with Andrew Whelton, an environmental engineer who investigates chemical risks during disasters.

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, Andrew J. Whelton, Professor of Civil, Environmental & Ecological Engineering, Director of the Healthy Plumbing Consortium and Center for Plumbing Safety, Purdue University.

Let’s start with what was in the train cars. What are the most concerning chemicals for human health and the environment long term, and what’s known so far about the impact?

The main concerns now are the contamination of homes, soil and water, primarily from volatile organic compounds and semivolatile organic compounds, known as VOCs and SVOCs.

The train had nearly a dozen cars with vinyl chloride and other materials, such as ethylhexyl acrylate and butyl acrylate. These chemicals have varying levels of toxicity and different fates in soil and groundwater. Officials have detected some of those chemicals in the nearby waterway and particulate matter in the air from the fire. But so far, the fate of many of the chemicals is not known. A variety of other materials were also released, but discussion about those chemicals has been limited.

State officials disclosed that a plume of contamination released into the nearby creek had made its way into the Ohio River. Other cities get their drinking water from the river, and were warned about the risk. The farther this plume moves downstream, the less concentrated the chemical will be in water, posing less of a risk.

Long term, the greatest risk is closest to the derailment location. And again, there’s limited information about what chemicals are present – or were created through chemical reactions during the fire.

It isn’t clear yet how much went into storm drains, was flushed down the streams or may have settled to the bottom of waterways.

There was also a lot of combusted particulate matter. The black smoke is a clear indication. It’s unclear how much was diluted in the air or fell to the ground.

How long can these chemicals linger in soil and water, and what’s their potential long-term risk to humans and wildlife?

The heavier the chemical, often the slower it degrades and the more likely it is to stick to soil. These compounds can remain for years if left unaddressed.

After the Kalamazoo River oil pipeline break in Michigan in 2010, the U.S. Environmental Protection Agency excavated a tributary where the oil settled. We’ve also seen from oil spills on the coasts of Alaska and Alabama that oil chemicals can find their way into soil if it isn’t remediated.

The long-term impact in Ohio will depend in part on how fast – and thoroughly – cleanup occurs.

If the heavily contaminated soils and liquids are excavated and removed, the long-term impacts can be reduced. But the longer removal takes, the farther the contamination can spread. It’s in everyone’s best interest to clean this up as soon as possible and before the region gets rain.

Air-stripping devices, like this one used after the derailment, can help separate chemicals from water. U.S. EPA

Booms in a nearby stream have been deployed to capture chemicals. Air-stripping devices have been deployed to remove chemicals from the waterways. Air stripping causes the light chemicals to leave the water and enter air. This is a common treatment technique and was used after an 2015 oil spill in the Yellowstone River near Glendive, Montana.

At the derailment site in Ohio, workers are already removing contaminated soil as deep as 7 feet (about 2 meters) near where the rail cars burned.

Some of the train cars were intentionally drained and the chemicals set on fire to eliminate them. That fire had thick black smoke. What does that tell you about the chemicals and longer-term risks?

Incineration is one way we dispose of hazardous chemicals, but incomplete chemical destruction creates a host of byproducts. Chemicals can be destroyed when heated to extremely high temperatures so they burn thoroughly.

The black smoke plume you saw on TV was incomplete combustion. A number of other chemicals were created. Officials don’t necessarily know what these were or where they went until they test for them.

We know ash can post health risks, which is why we test inside homes after wildfires where structures burn. This is one reason the state’s health director told residents with private wells near and downwind of the derailment to use bottled water until they can have their wells tested.

The EPA has been screening homes near the derailment for indoor air-quality concerns. How do these chemicals get into homes and what happens to them in enclosed spaces?

Homes are not airtight, and sometimes dust and other materials get in. It might be through an open door or a window sill. Sometimes people track it in.

So far, the U.S. EPA has reported no evidence of high levels of vinyl chloride or hydrogen chloride in the 400 or so homes tested. But full transparency has been lacking. Just because an agency is doing testing doesn’t mean it is testing for what it needs to test for. Media reports talk about four or five chemicals, but the manifest from Norfolk Southern also listed a bunch of other materials in tanks that burned. All those materials create potentially hundreds to thousands of VOCs and SVOCs.

Are Government Officials Testing for Everything they Should?

People in the community have reported headaches, which can be caused by VOCs and other chemicals. They’re understandably concerned.

Ohio and federal officials need to better communicate what they’re doing, why, and what they plan to do. It’s unclear what questions they are trying to answer. For a disaster this serious, little testing information has been shared.

In the absence of this transparency, misinformation is filling that void. From a homeowner’s perspective, it’s hard to understand the true risk if the data is not shared.