“We’re Not Finished Yet” According to the FOMC Post Meeting Statement
The Federal Open Market Committee (FOMC) voted to raise its target rate on overnight interest rates from 5.00% – 5.25% to 5.25%-5.50% after the July 2023 meeting. This 25 bp move follows a pause in rate hikes decided during the June meeting. The Fed still maintains a hawkish stance after raising the Fed Funds rate to its highest level in 22 years and leaving quantitative tightening (QT) targets unchanged.
The implementation note following the meeting spells out QT implementation to reduce the Fed’s balance sheet as:
“Roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing in each calendar month that exceeds a cap of $60 billion per month. Redeem Treasury coupon securities up to this monthly cap and Treasury bills to the extent that coupon principal payments are less than the monthly cap.”
“Reinvest into agency mortgage-backed securities (MBS) the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency MBS received in each calendar month that exceeds a cap of $35 billion per month.”
QT is an important part of the Federal Reserve Bank reducing the stimulus effect of having injected, through quantitative easing (QE), substantial amounts of money into the U.S. economy.
Words in the statement, particularly those changed from the prior meeting, are placed under the spotlight. In June, the FOMC members felt the U.S. economy was “growing” at a “modest” pace. Now it sees “more growth”—at a “moderate” level. This indicates that they may believe they have a higher need to continue tightening credit conditions.
At the previous meeting a Summary of Economic Projections (SEP) for the Fed Funds Rate indicated the Fed expected two additional 25 bp increases. While no SEP is available after the July meeting, the view the economy has become stronger, would suggest that at a minimum, another 25 bp is likely.
The FOMC as the monetary policy arm of the Federal Reserve is, as it says, “data dependent” when determining what tightening or other moves may be appropriate in the future.
A Broad-Based Recovery in Shares of Internet & Digital Media Stocks
Despite macroeconomic headwinds that include higher interest rates, a regional banking crisis, elevated inflation and a war in Europe, the S&P 500 powered higher for the third quarter in a row. The S&P 500 Index continued its streak of steady increases, with an 8% increase in the Index in 2Q 2023, which followed a 7% increase in 1Q 2023 and a 7% increase in 4Q 2022. The broad index is up a healthy 24% since the end of the third quarter of 2022. The S&P 500 bottomed on October 12, 2022, and is up 26% from that date through mid-July.
The S&P 500’s performance was driven primarily by its largest constituents. As a market weighted index, the largest stocks have an outsized impact on its performance, and that was certainly the case in 2Q. Eight of the largest stocks in the S&P 500 Index were up in 2Q 2023 by 2x-3x or more than the Index’s 8% gain. Stocks that powered the Index higher included Nvidia (NVDA, +52%), Meta Platforms (a.k.a Facebook, +META, +35%), Netflix (NFLX, +28%), Amazon (AMZN, +26%), Tesla (TSLA, +26%), Microsoft (MSFT, +18%), Apple (AAPL, +18%) and Google (GOOGL, +15%).
Noble’s Internet and Digital Media Indices, which are also market cap weighted, also powered higher thanks to the biggest constituents in their respective Indices. Each of these Indices posted double digital percent increases, with only the exception being Noble’s Video Gaming Index (+5%), which slightly underperformed the broader market/S&P Index. For the second quarter in a row, the best performing index was Noble’s Social Media Index, which increased by 34% in 2Q 2023, followed by Noble’s Ad Tech Index (+24%), MarTech Index (+18%), Digital Media Index (+16%), and Video Gaming Index (+5%).
STOCK MARKET PERFORMANCE: INTERNET AND DIGITAL MEDIA
Meta Powers the Social Media Index Higher
We attribute the strength of the Social Media Index to its largest constituent, Meta Platforms, whoseshares increased by 35% in the second quarter. We noted last quarter that Meta appeared to be returning to its roots and focusing on profitability, rather than its nascent and riskier web3 initiatives. That return to its core strengths has been greatly rewarded by investors. Shares of Meta were up 225% from its 52-week low of $88.09 per share in early November through the end of June. Shares are up another 8% since the start of the third quarter with the launch of Threads, Meta’s answer to Twitter. Over 100 million people signed up for Threads within the first five days of its rollout. Meta has not yet begun to monetize this opportunity, but it will clearly add to its growth in coming quarters.
Ad Tech Stocks Embark on a Broad-Based Recovery Following a Difficult 2022
Noble’s AdTech Index increased by 24% in 2Q 2023, and this performance was very broad based, with 15 of the 24 stocks in the sector up, and a dozen of the stocks up by double digits. Ad Tech stocks that performed best during the quarter include Applovin (APP, +63%), Magnite (MGNI, +47%), Tremor International (TRMR, +37%), Pubmatic (PUBM, +32%), Double Verify (DV, +29%), The Trade Desk (+27%), and Integral Ad Science (IAS, +26%). Ad Tech stocks were the worst performing sector in our universe in 2022, with the index down 63% for the year in 2022. The strong performance in 2Q 2023 in many respects reflects a bounce back off multi-year lows for several stocks. Year-to-date, one standout in particular is Integral Ad Science, whose shares were up 104% in the first half of 2023. The company continues to expand its product suite, scale its social media offerings (i.e., for TikTok) and is well positioned to continue to benefit from the shift from linear TV to connected TV (CTV). The company is benefiting from new partnerships with YouTube and Netflix and shares likely benefited during the quarter from anticipation of the company’s mid-June analyst day presentation.
Noble’s MarTech Index was up 18%, with performance within the group also broad based. Thirteen of the 20 stocks in the Index were up in the quarter. MarTech stocks that performed best during the quarter include Cardlytics (CDLX, +86%), Shopify (SHOP, +35%), Live Ramp (RAMP, +30%), Adobe (ADBE, +27%), and Hubspot (NUBS, +24%). MarTech stocks were victims of their own success: the group traded at double digit revenue multiples in 2021, but the sector’s revenue multiples were more than halved in 2022. The group currently trades at 5.3x 2023E revenues, up from 4.1x 2023E revenues at the end of the first quarter, and 3.5x 2023E revenues at the start of the year.
Finally, the Digital Media Index was up 16% in 2Q 2023, and here again, the performance was broad based with 8 of the 12 stocks in the Index posting gains. Digital Media stocks that performed best during the quarter include Fubo TV (FUBO, +72%), Travelzoo (TZOO, +31%), Netflix (NFLX, +28%), Interactive Corp (IAC, +22%), and Spotify (SPOT, +20%). Year-to-date, the two best performing Digital Media stocks are Spotfiy (+103% YTD), which has shifted its priority to running a profitable company and took additional steps in 2Q to achieve it, for instance, by consolidating and streamlining several of its podcast company acquisitions from recent years. The second best performing Digital Media stock through the first half of the year was Travelzoo (TZOO), whose shares were up 77% in the first half of the year. The company continues to benefit from pent up demand that helped a surge in travel as the pandemic ebbed. Lodging and domestic travel demand rebounded first, but Travelzoo appears to be benefiting from cruises and international travel, where pent up demand took longer to recover.
2Q 2023 M&A – Global Deal Market Fell by 36% Year-Over-Year
According to Dealogic, global M&A fell by 36% to $733 billion in 1Q 2023 compared to $1.14 trillion in 2Q 2022, with high interest rates and a stand-off over the U.S. debt ceiling cited as reasons for caution in the M&A market. Uncertainty is the biggest issue impacting M&A. However, 2Q 2023 global M&A levels represent a 22% increase from 1Q 2023 global M&A of $601 billion in the first quarter of 2023.
In the U.S., M&A deal values decreased by 30% to $318 billion, while Europe and Asia Pacific volumes decreased by 49% and 24% respectively. Private equity buyouts have been particularly challenged with year-to-date values down 59% to $197 billion in the first half of the year, following a 56% decrease in 2Q 2023 vs. the year-ago period. It is difficult to tell how much the regional banking crisis in the U.S. played a role in these declines, but to the extent that regional banks play a role in middle market M&A, there is less credit available in the middle market, which has impacted valuations.
2Q 2023 Internet and Digital Media M&A – A Mixed Bag
Based on Noble’s analysis, deal making in the second quarter of 2023 in the Internet and Digital Media sectors slowed, but was surprisingly weaker on a year-over-year basis than on a quarter-over-quarter basis. The total number of deals we tracked in the Internet and Digital Media space actually increased to by 3% to 187 deals in 2Q 2023 compared to 181 deals in 2Q 2022. On a sequential basis, the total number of deals decreased by 7% compared to 202 deals in the first quarter of 2023.
The biggest change was in the second quarter’s M&A deal value, where the total dollar value of deals fell by 82% to $17.0 billion of announced deals in 2Q 2023 compared to $95.5 billion in announced deals in 2Q 2022. While total deal value of announced deals decreased significantly year-over-year, on a sequential basis, deal value increased by 82% from $8.4 billion in deal value in 1Q 2023 to $17 billion in 2Q 2023.
From a deal volume perspective, the most active sectors we tracked were Digital Content (53 deals), MarTech (52 deals) and Agency & Analytics (40 deals). From a dollar value perspective, Digital Content led the way with $13.4 billion in transactions, followed by MarTech ($1.25 billion), Information Services ($1.23 billion) and eCommerce ($800 million). It was a very slow quarter for Ad Tech deals, where we tracked just 9 transactions for a total of $248 million.
Video Gaming Deals Drive the Largest Transactions in 2Q 2023
It is notable that we tracked 16 transactions that were greater than $100 million in dollar value during the quarter and half of those transactions were in the Digital Content sector. In fact, the four largest transactions in the quarter were digital content transactions, with two of these deals being in the video gaming sector: Savvy Games Group’s $4.9 billion acquisition of Scopely, and Light & Wonder’s (previously known as Scientific Games Corp) $849 million announcement that it would acquire SciPlay Corporation. The largest deals in the quarter by dollar value are shown below.
TRADITIONAL MEDIA COMMENTARY
The following is an excerpt from a recent note by Noble’s Media Equity Research Analyst Michael Kupinski
The Recession Is Here
The economy grew post pandemic through the first quarter of 2023, reflecting a rebounding economy, fueled by government spending. But, economic activity is slowing, taking pressure off of inflation. Nonetheless, the Fed seems intent on pushing interest rates higher, likely through the balance of this year. Most economists anticipate that the Fed will raise interest rates by 25 basis points two times in the second half of this year. Not only will the interest rate increases be a headwind for the economy, but government spending, a key driver to the economy this year, is likely to wane. Recent economic forecasts anticipate GDP to contract over the next few quarters, a classic definition of an economic recession. The Conference Board of Economic Forecasts anticipates that the US economy will contract -1.2% in 3Q 2023, -1.9% in 4Q 2023, and -1.1% in 1Q 2024.
This does not paint a favorable picture for advertising in the very near term. Advertising is highly correlated to personal disposable income, particularly discretionary income. If consumers have discretionary income, companies advertise in anticipation of consumer spending. Disposable income has declined over the past 18 months. Not surprisingly, economically sensitive national advertising has been down nearly 4 quarters and at high double digit rates. Given the significant declines, as much as 25% in each quarter for the past year, national advertising trends should moderate, given that the comps get easier. Even with an economic downturn becoming more visible, it is possible that national advertising declines may moderate.
National advertisers tend to spend when there is light toward the end of an economic recession, when consumer personal disposable income shows signs that it will improve and consumers have the propensity to spend. In our view, that light at the end of the tunnel is still pretty dim given the economic forecast that anticipates a decline in GDP through 1Q 2024. While the visibility of an improvement in national advertising seems to have improved as we enter an economic downturn, especially given the easing comps and the benefit from political advertising (expected to begin in 3Q 2023), we think that it is too early to be optimistic. We believe that the length and severity of an economic downturn is not yet visible.
STOCK MARKET PERFORMANCE: TRADITIONAL MEDIA
What does this mean for the stock market and for media stocks? The recent increases in Fed Funds rates had little effect on the general stock market as measured by the S&P 500 Index. Unfortunately, late cycle and economically sensitive media companies declined or under-performed the stock market. In spite of Fed Fund rate increases over the past year, the S&P 500 Index increased 18% in the last 12 months. The anticipation of an economic recession, however, weighed on media stocks.
The stock performance of the various media sectors generally under-performed the market. The exception to the poor performance were the Internet and Digital Media stocks, which had a broad-based recovery. Is it possible that early cycle media stocks will outperform the general market in the near term? In our view, yes, but, this may mean that the general market may decline as media stocks decline less. Historically, it has been the case to buy media stocks in the midst of a recession as media stocks strongly outperform the general market in an economic recovery. But given the likely disappointment in revenue in the coming quarters, it is likely that media stocks will be volatile as investors weigh the near-term revenue and earnings disappointments to the prospect of a revenue rebound in an improved economic scenario. This would suggest that if one were to try to time the stocks, investors may want to wait a quarter or two and buy on the improved momentum. This may mean that one might miss the large gains. For long-term investors, we believe that we are nearer to the bottom and that the downside appears relatively limited and valuations appear compelling. But, given the anticipated volatility in the near term, media investors should look for opportunistic purchases and accumulate positions in their favorite media names.
Traditional media stocks largely underperformed the general market over the LTM, the Radio sector was the hardest hit. The Noble Radio Index decreased 38% over the latest twelve months, compared with the general market increasing 18%, as measured by the S&P 500 over the same period. The Television Index was down 15% and the Publishing index outperformed the general market, increasing 28% over the last year. Notably, there were company stock performance disparities within each sector. Given the indices are market cap weighted, larger market capitalized companies skewed the indices’ performance.
The traditional media industry is still finding its footing in the difficult economic environment, given the indices performance in Q2. While the Newspaper and Radio indices performed better in Q2 than Q1, the TV Index did not. The S&P 500, increased 8% over the last quarter and outperformed all but one traditional media sector. The Newspaper Index, which increased 9% over the same period narrowly outperformed the general market. The TV Index was the hardest hit traditional media sector and decreased -11%. While the Radio index underperformed the market in Q2, it improved upon a difficult Q1 and increased 3%.
Broadcast Television
Are ad trends really improving?
The TV Index underperformed the general market in the second quarter. While none of the stocks in the TV Index increased in the second quarter, many performed better than the market cap weighted return of -11%. Fox Corporation (FOXA; was flat at 0%), E.W Scripps (SSP; down 33%), Nexstar (NXST; down 4%) and Gray Television (GTN; down 10%) were among the best performing stocks in the hard-hit TV index. The stocks hit the hardest in Q2 were Sinclair Broadcast Group (SBGI; down 20%) and Entravision (EVC; down 27%). Given the recent turmoil in TV stock performances we view the depressed prices as a potential opportunity given the prospect of an advertising recovery over the next few quarters.
While there have been some recent reports indicating that television advertising is improving, possibly related to increased political advertising and auto advertising in the third quarter, we remain skeptical that the improvement is sustainable given the weakening economy. Nonetheless, the TV stocks appear cheap.
From a valuation perspective, Paramount (PARA) trades well above industry peers such as Entravision (EVC) and E.W Scripps (SSP), which trade at multiples well below the industry high. While E.W Scripps had modest year over year revenue decline, we believe it will benefit from favorable retransmission renewal revenue and improved margins on said revenue. Given the SSP shares low float, the shares tend to underperform when industry is out of favor and overperform when the industry is back in favor. As for Entravision, we view the company’s digital transformation positively, given the shares are trading at a modest 3.9 times Enterprise Value to our 2024 Adj. EBITDA estimate we believe there is limited downside risk. In our view, the EVC shares and SSP shares both offer a favorable risk reward relationship and are poised to benefit from an advertising recovery.
Broadcast Radio
While the Radio Index underperformed the S&P 500 in Q2, it was an improvement from a difficult Q1. Notably, there were a few strong performances in the market cap weighted index. Beasley Broadcast Group (BBGI, up 24%) , Cumulus Media (CMLS, up 11%) and Townsquare (TSQ, up 49%) all strongly outperformed the S&P 500 in Q2. The largest stocks in the group did not perform well in the quarter skewing the index lower, Audacy (AUD, up 3%) and iHeart Media (IHRT; down 7%). The second quarter stock performances were a mixed bag and largely did not reflect the first quarter operating results. Most companies had modest revenue growth. The larger Radio companies that rely more on national advertising had the greatest declines of YoY revenue. With CMLS being the exception, the larger Radio companies underperformed relative to Radio companies with a stronger digital and highly localized presence.
Some Radio companies have strong digital businesses and highly localized footprints, which provides some shelter from weakness in national advertising. Those companies include Townsquare, Beasley Broadcast Group, Salem Media (SALM; down 12%) and Saga Communications (SGA, down 4%). While the shares of Saga Communications (SGA) were down 4%, the performance did not reflect its favorable first quarter operating results. Importantly, Saga grew revenues a modest 1.3% and had an above average Q1 EBITDA margin of 9.6%. Saga has a highly localized footprint, as approximately 90% of revenues come from local sources. Furthermore, the company has been placing more importance on growing a profitable digital business in recent years. While Saga’s Digital business is early in its development, management is focused on growing digital revenues from 7.5% of total revenue in Q1 to 20% of total revenue over the next couple years. Additionally, the company is likely to maintain a strong cash position given the economic uncertainty.
Townsquare Media (TSQ), Salem Media (SALM), Beasley Broadcast (BBGI) and Saga Communications (SGA) have all diversified their revenue streams, and while not immune to the economic headwinds, their digital businesses and local footprints should offer some ballast to the more sensitive radio business.
We believe that radio advertising pacings likely will be problematic in the second half given the economic headwinds. Unlike Television, the industry does not benefit as much from political advertising. We expect that advertising pacings likely will be lower in Q3 than the Q2 results. It is likely that many radio companies, especially those with higher debt leverage, will implement cost cutting measures. With many of the radio companies already relatively lean from the Pandemic, it is likely that such measures will be difficult.
Publishing
The Publishing industry is no exception to the advertising weakness that is impacting the broader media landscape. Revenues are likely to continue to decline, despite an already weak performance in the first quarter of the year. Revenue were predominantly negative in 1Q23. The advertising challenges are hitting the traditional print side of the publishing business hardest. For example, Lee Enterprises (LEE) reported a 10% decline in print advertising revenue in 1Q23, while digital advertising grew a modest 2%. The company’s adj. EBITDA generation fell 15% compared with a more moderate 2% drop in total company revenues.
Not surprisingly, the dampened industry revenue resulted in lower industry cash flow generation with EBITDA margins averaging in the 10% range. Yet despite the constraints on cash flow generation on Lee and the other Publishers, we believe the companies have the ability to cut costs to help offset the pressure on cash flow generation. In particular, companies could cut costs in their print manufacturing and distribution operations, reducing overhead in the same business segments where revenues are expected to lag. Publishing companies have a playbook on cutting legacy print costs and have the ability to maintain cash flow. However, cost cuts can take time to go into full effect, which could result in poor cash flow performance over the next quarter or so.
In spite of the nearer term economic headwinds impacting the operating performance of the industry, we believe that the industry is near an inflection point towards revenue growth. This dynamic is related to the degree of the recovery in its digital media businesses, a key driver to the industry’s overall revenue performance. While there are secular challenges to the industry’s print business, digital revenues account for an increasing portion of total revenues. For companies like Lee Enterprises, digital accounts for over 38% of total revenues in the most recent quarter. In our view, publishing companies will be a player in the advertising recovery as economic prospects improve.
Furthermore, we believe that stock valuations are compelling. The New York Times (NYT) trades well above the levels of the rest of its peers. In comparison, Lee and Gannett appear to be compelling. However, both Lee and Gannett are highly levered. Yet, in our view, Lee’s debt profile has several favorable characteristics, such as a fixed 9% annual rate, no fixed principal payments, no performance covenants and a 25-year maturity. LEE shares trade near 5.3 times enterprise value to our 2024 adj. EBITDA forecast, and with a favorable digital transformation of the business well underway, LEE shares could close the valuation gap with some of its higher trading peers.
This newsletter was prepared and provided by Noble Capital Markets, Inc. For any questions and/or requests regarding this news letter, please contact Chris Ensley
DISCLAIMER
All statements or opinions contained herein that include the words “ we”,“ or “ are solely the responsibility of NOBLE Capital Markets, Inc and do not necessarily reflect statements or opinions expressed by any person or party affiliated with companies mentioned in this report Any opinions expressed herein are subject to change without notice All information provided herein is based on public and non public information believed to be accurate and reliable, but is not necessarily complete and cannot be guaranteed No judgment is hereby expressed or should be implied as to the suitability of any security described herein for any specific investor or any specific investment portfolio The decision to undertake any investment regarding the security mentioned herein should be made by each reader of this publication based on their own appraisal of the implications and risks of such decision This publication is intended for information purposes only and shall not constitute an offer to buy/ sell or the solicitation of an offer to buy/sell any security mentioned in this report, nor shall there be any sale of the security herein in any state or domicile in which said offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state or domicile This publication and all information, comments, statements or opinions contained or expressed herein are applicable only as of the date of this publication and subject to change without prior notice Past performance is not indicative of future results.
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Adam Aron Explains the Reasons Share Conversion and Issuance is Good for APE Shares
Meme stocks are getting attention again as the movie Dumb Money is set for release in late September, GameStop (GME) is implementing a strategy to use its stores as fulfillment centers, and AMC Theatres (AMC) has a court ruling on its APE shares that has added significant volatility, including a 67% upward spike after hours on Friday July 21. The AMC story is involved and likely to cause wide swings until resolved as investors wrestle with guessing what a new ruling means for the company’s financial strength, and whether the judge’s decision could be overturned on appeal or through shareholder approval.
The main source of the ongoing dramatic moves in AMC stems from its proposed APE shares conversion. These preferred shares were provided as a dividend with a 1:1 conversion feature. If/when converted to regular AMC shares, they will dilute the regular shares. When issued, APE shares were considered a brilliant financing mechanism and method to determine if any fraudulent units were used to create a naked short.
In late July a judge blocked the proposed settlement on AMC Entertainment Holdings stock conversion plan that would also allow the company to issue more shares. The stock had been depressed in anticipation of the additional shares that would have been created. With the thought that additional shares won’t be entering the market, common shares (AMC) soared, and preferred shares (plummeted).
The Delaware chief judge Morgan Zurn said in her ruling that she cannot approve the deal, which would provide AMC common stockholders with shares worth an estimated $129 million. The company was sued in February for allegedly rigging a shareholder vote that would allow the entertainment company to convert preferred stock to common stock and issue hundreds of millions of new shares. The investors who sued alleged AMC had enacted the plan to circumvent the will of common stock holders who opposed the company diluting their holdings.
Without the proposed settlement, common stockholders and preferred shareholders would end up owning 34.28% and 65.72% of AMC, respectively. Under the ruling, common stockholders and preferred shareholders would own 37.15% and 62.85%, respectively.
Judge Zurn wrote that while the deal would compensate common stockholders for the dilution, they had no right to settle potential claims by holders of preferred stock in this way. The settlement received more than 2,800 objections from shareholders, a level of interest Zurn called “unprecedented.” She said “AMC’s stockholder base is extraordinary,” adding many “care passionately about their stock ownership and the company.”
But what appears short term to be good for common shares, may actually weaken the financial position of the company over time according to AMC’s chairman. In an open letter, AMC chairman Adam Aron wrote, “What may not be clear to AMC’s shareholders is that if the company is unable to convert APE shares, AMC will be forced to issue significantly more APE shares to cover its upcoming cash requirements.”
Aron explained AMC is burning cash at an unsustainable rate and warned that an inability to raise capital could force the company into bankruptcy. Selling more shares would enable it to pay down some of its $5.1 billion in debt. These financial matters are further complicated by the writers and actors strike which according to Aron could delay the release of movies currently scheduled for 2024 and 2025.
A Social Security Funded Study Demonstrates the Benefit of Including Equities
Should all or part of Social Security be invested in the stock market? A study out this month by the Center of Retirement Research (CRR) at Boston College uses evidence from the U.S. and Canada that shows that investing in equities through government retirement funds is feasible, safe, and effective. In 1984, before he became the Chairman of the Federal Reserve, Alan Greenspan headed a commission on Social Security (S.S.). While he was positive on stocks used for a portion of S.S., it was not part of the commission’s recommendation. Since then, equity returns have averaged about twice that of S.S. investments in U.S. Treasuries.
According to CRR, “evidence from the U.S. and Canada shows that such investing through government retirement funds is feasible, safe, and effective.”
The Center for Retirement Research is a non-profit research institute that studies retirement income security. It was established in 1998 as part of the Retirement Research Consortium and is funded by the U.S. Social Security Administration. The CRR’s mission is to produce first-class research and educational tools and forge a strong link between the academic community and decision-makers in the public and private sectors. The CRR conducts a wide variety of research projects on topics such as Social Security, private pensions, annuities, and retirement savings. It also publishes a variety of research reports, data sets, and educational materials. Policymakers, academics, and the media widely cite the CRR’s research.
Background
The merits of investing a portion of the Social Security trust fund in equities have been discussed for decades. With potentially higher returns compared to safer assets, such as Treasury bonds, equity investments could potentially reduce the need for tax increases or benefit cuts to ensure the long-term solvency of the system. However, this approach also carries risks and raises concerns about government interference in private markets and misleading accounting practices that may give the impression that issuing bonds and buying equities can effortlessly generate wealth for the government.
There are real-world examples that one can point to that demonstrate that governments can engage in equity investments sensibly. Canada, for instance, has a large, actively managed fund that adheres to fiduciary standards and employs conservative return assumptions. In the United States, both the Railroad Retirement System and the Federal Thrift Savings Plan have invested in a diverse range of assets without disrupting private markets. In these cases, the government’s role is primarily passive.
Despite the demonstrated successes, the question remains whether equity investments should be considered as a solution for Social Security. The prerequisite for such an approach is a trust fund with substantial assets available for investment. Currently, the existing trust fund is being depleted, and the likelihood of raising taxes to rebuild it is low. Borrowing to rebuild the trust fund does not guarantee any additional resources for Social Security.
After the Greenspan amendments in 1983, which resolved the problem for a time with taxing S.S., future deficits began to reappear. President Clinton tasked the 1994-1996 Advisory Council on Social Security with considering options for achieving long-term solvency. The council could not reach a consensus on a single plan, and its members put forward three different proposals to close the funding gap, all of which included some form of equity investment. Two proposals involved individual accounts for equity investment, while the third recommended direct equity investment using a portion of the trust fund reserves.
The primary attraction of equity investment lies in its higher expected rate of return compared to safer assets like Treasury bonds or bills. By restoring balance to Social Security, the need for tax increases or benefit cuts could be reduced (see Table 1). Economists also argue that effective risk-sharing across a lifespan requires individuals to bear more financial risk when young and less when old. As young individuals possess limited financial assets, investing the trust fund in equities becomes a means to achieve this goal.
Table showing the average returns and standard deviation of different assets, 1928-2022
Critics expressed concerns that equity investment by Social Security could have adverse effects on the stock market and corporate decision-making while also creating the false perception that trading bonds for stocks yields magical money.
Addressing these concerns involves answering the following questions:
How significant is the equity investment initiative relative to the overall economy? According to a 2016 study, if Social Security had begun investing in the stock market in 1984 or 1997, it would now own approximately 4 percent of the market. For comparison, state and local pension plans currently hold about 5 percent of total equities.
How do government officials select investments? Proponents of equity investment for the trust fund assume that the government would take a passive role. However, the Canada Pension Plan and the Railroad Retirement system, as discussed later, adopt a more active approach.
Do government agencies use expected returns or risk-adjusted returns to evaluate the impact of equities on plan finances? Crediting expected returns quantifies the potential contribution of equities to addressing Social Security’s financing shortfall but may falsely suggest that the government can generate money simply by selling bonds and buying stocks. Adjusting for risk avoids this misperception by acknowledging that returns are not guaranteed, but the risk adjustment would yield no immediate impact from equity investment on the system’s finances. Higher returns are only recognized after they are realized.
Three Federal Government Plans with Equity Investments
The Canada Pension Plan is a major component of Canada’s retirement system, initially established in 1966 as a pay-as-you-go plan with a modest reserve, similar to the U.S. Social Security program. This approach was suitable when the country had a young population and rapidly growing wages. However, factors such as declining birth rates, longer life expectancies, and lower real wage growth led to increased plan costs and the prospect of rising payroll contribution rates.
To address intergenerational fairness and ensure the long-term financial sustainability of the plan, Canada enacted legislation in 1997. The legislation increased payroll contributions to projected long-term rates and introduced equity investments into the fund. Any future changes to the plan must be fully funded.
The investment strategy was implemented through the creation of the CPP Investment Board (CPPIB), a government-owned corporation that operates independently from the CPP itself and is managed at arm’s length from the government. The CPPIB’s mandate is to invest excess CPP revenues in a way that maximizes returns without incurring undue risk, solely for the benefit of CPP contributors and beneficiaries.
The CPPIB has built a diverse portfolio comprising stocks, bonds, real estate, infrastructure projects, and private equity (see Figure 1). As of 2023, the total assets amount to 570 billion CAD.
Pie chart showing the asset class composition of the Canada Pension Plan, as of March 31, 2023
To reduce risks associated with future Canadian economic and demographic conditions, the CPPIB diversifies its investments globally (see Figure 2). Therefore, the fund’s domestic investments are relatively small compared to the country’s GDP (2.8 trillion CAD) and stock market (3.9 trillion CAD).
Pie chart showing the geographic composition of the Canada Pension Plan assets, as of March 31, 2023
The CPPIB comprises six departments responsible for investing and managing the assets, employing highly compensated in-house managers. Over the past decade, the fund has achieved an annualized net return of 10 percent (see Figure 3).
Bar graph showing the net annualized nominal returns for the Canada Pension Plan by asset class, as of March 31, 2023
The CPPIB also considers economic, social, and governance factors in its investment decisions when managers believe that addressing these issues will generate superior long-term returns. The Board exercises proxy voting at annual meetings and encourages companies to consider climate risks and develop viable transition strategies. Rather than engaging in blanket divestment from high-emitting sectors, the managers believe in using the CPPIB’s influence constructively.
The Board assesses risk using a minimum and a target level. The base CPP’s minimum risk level consists of a portfolio divided equally between Canadian government bonds and global public equities. In 2016, legislation was passed that increased CPP contributions and benefits. The minimum risk levels for the additional component are slightly lower: 60 percent bonds and 40 percent global equities.
The actuarial reports adopt conservative return assumptions, as the actual investment earnings have consistently exceeded projected earnings. Under these prudent assumptions, both the base CPP and the additional CPP components have been projected to remain sustainable for a 75-year period. If the system’s finances are projected to be imbalanced, an additional safeguard triggers an increase in contribution rates and a freeze in benefit indexation if policymakers fail to address the projected imbalance.
The Canadian investment initiative has proven successful while addressing the concerns raised by critics. Investments represent a small share of the Canadian economy, adhere to strict fiduciary standards, and the assumed investment returns used for evaluating the solvency of the CPP are conservative.
U.S. Railroad Retirement System
The Railroad Retirement system was created by Congress in 1934 to assume responsibility for the rail industry’s ailing pension plan. Initially funded on a pay-as-you-go basis through payroll taxes on workers and employers, the program had a modest trust fund invested solely in government bonds. However, by the 1990s, the trust fund’s assets had grown to four times the annual outlays, reaching historically high levels. There was a belief that further growth could be achieved through equity investments, leading management and labor to negotiate a proposal for such investments. However, given that Railroad Retirement is a government program, the plan required congressional approval.
Congress expressed concerns about potential political influence on investment decisions. To address this, Congress established the National Retirement Investment Trust (NRRIT). The NRRIT comprises six trustees, with three selected by management and three by labor, who then choose a seventh independent trustee. Congress also imposed a private-sector fiduciary mandate on these trustees, requiring them to invest the government’s assets solely in the interest of plan participants. Initially, 65 percent of trust fund assets were allocated to equities. Over time, the NRRIT expanded its portfolio beyond equities to include real estate, private equity, and private debt. As of 2023, the net assets in the trust fund amounted to $27 billion. External managers handle the actual investing.
The evaluation of equity use in reform proposals raised a key issue. While the Social Security actuaries credit equities with their expected rate of return, the Office of Management and Budget, in assessing the financial implications of the Railroad Retirement proposal, disregarded the higher expected return and employed a risk-adjusted return—the long-term Treasury rate—to project future trust fund balances. Currently, the Railroad Retirement actuaries assume a 6.5-percent return, striking a balance between actual returns and a risk-adjusted rate.
Bar graph showing the Railroad Retirement Trust annualized returns, as of March 31, 2023
Federal Thrift Savings Plan
Established in 1986, the Federal Thrift Savings Plan (TSP) boasts 6.5 million participants and approximately $800 billion in assets. Concerns among members of Congress regarding potential executive branch pressure on plan fiduciaries to select investment options that align with its policy goals prompted the establishment of stringent safeguards.
The Federal Retirement Thrift Investment Board, responsible for administering the TSP, has limited discretion compared to other plan fiduciaries when setting investment policy. Congress determines the number and types of investment funds that the Board can offer, and any expansion or change requires congressional approval. When choosing benchmark indices for the investment funds, the Board is restricted to those that are widely recognized and reasonably represent the entire market. The Board is also prohibited from removing any stock from the index and categorically barred from using proxy voting power to influence corporate decision-making.
Francis Cavanaugh, the first executive director of the TSP’s Board, reported no difficulties in selecting an index or obtaining competitive bids from large index fund managers. He encountered no instances of government interference in the market. In essence, the TSP provides a model for structuring Social Security’s equity investment, with a passive approach through index funds and no proxy voting.
Does Equity Investments Make Sense in 2023?
In theory, the answer is “yes.” Plans that have adopted equity investments have consistently outperformed bond yields, even in the face of economic downturns such as the dot-com recession and the financial crisis. Concerning critics’ concerns, the experience of the TSP offers guidance on separating government intervention from actual investment decisions. Additionally, evaluating returns on a somewhat risk-adjusted basis, similar to the approach employed by the Railroad Retirement system, prevents the perception of easy money.
However, investing trust fund assets in equities necessitates a substantial trust fund. Unfortunately, the Social Security trust fund that emerged from the 1983 amendments is rapidly diminishing. Rebuilding the trust fund would require a tax increase to cover current program costs and generate an annual surplus to accumulate reserves.
Although such an initiative is not without precedent—the United States and Canada both raised payroll contributions above current program costs and accumulated fund assets—present circumstances differ significantly from those in 1983. The majority of cost increases lie in the past. Even if Congress were to raise the payroll tax rate by 4 percentage points starting in 2030—an amount roughly needed to cover benefits over the next 75 years—it would only result in minor temporary surpluses, followed by future cash-flow deficits. These surpluses would be less than 40 percent of those generated by the 1983 legislation
Line graph showing the U.S. Social Security income and cost rates as a percentage of taxable payroll, assuming a 4.0-percentage-point tax increase in 2030, 1980-2100
Considering the unlikelihood of Congress taking action well before 2030, the combination of current trust fund balances and immediate surpluses resulting from the tax increase would only lead to modest accumulation.
Furthermore, it is questionable whether there is enough political will to implement such measures, and the case for building a large trust fund is not particularly compelling. With costs projected to stabilize, it is challenging to argue that today’s workers should pay more to build a trust fund that will benefit future workers.
If Congress is unwilling to raise taxes sufficiently to create a substantial trust fund, could borrowing be a viable solution? One proposal suggests that the government borrow around $1.5 trillion to invest in stocks, private equity, and other instruments with higher expected returns than government debt interest. In the interim, the government would continue borrowing to cover Social Security’s shortfall. After 75 years, the trust fund proceeds could be used to repay the borrowed funds that financed benefit payments.
This proposal differs fundamentally from Canada’s approach, which involves contributing additional funds to build up a reserve for the future. On the contrary, creating a trust fund with borrowed money that the government must repay with interest means that any proceeds would be limited to returns exceeding the bond rate. Fixing Social Security requires genuine economic changes, such as benefit reductions or increased income. This proposal offers no real solutions except the opportunity to pocket returns exceeding the bond rate.
Critics liken this proposal to advising a middle-aged couple who realize they have insufficient retirement savings to not reduce their spending, plan for reduced expenses after retirement,
Take Away
The US Social Security System investing in equities through retirement program trust funds is a viable concept that has been proven feasible, safe, and effective in both Canada and the United States. So, in theory, this idea could have worked, but can it may be late to attempt now. This is because one critical component is now deficient. SS no longer has a sizable trust fund to invest. And rebuilding the trust fund through additional taxes or borrowing may not be feasible.
While the mechanics are manageable, the window may have passed for raising taxes enough to accumulate a meaningful Social Security trust fund that would make investing in equities worthwhile and prudent according to the CRR.
Image: The author attending a stylish financial industry event in Boca Raton, FL
The Emerging Financial Centers and the Brain Drain from Other Cities are Changing Where Deals Get Done
They used to call it “god’s waiting room,” now they call it home.
If you haven’t guessed, I’m talking about Florida, and more specifically, the big-name financial firms that have either moved their headquarters to “Wall Street South” or have built a much larger presence in West Palm Beach, Miami, Fort Lauderdale, or the Tampa area. I made the move myself some years back after more than 20 years managing large funds for some of the most prestigious firms in NYC – now, some of those very firms are discovering what I have learned, that the weather, costs, and culture make both living and working a lot easier.
Each investment company that chooses South Florida as a region to grow its firm, brings even more sophisticated investors and dealmakers to those already in the state —face-to-face networking is now high caliber and done with ease. Everyone in the industry is benefitting from the closer proximity to each other and being able to meet and make introductions in an environment that, in my opinion, is much more conducive to making acquaintances, building trust, and even having some fun.
Florida is a Disruptor
My old firm, Goldman Sachs, just built out 35,000 feet of office space in the Miami, Brickell area. This is on top of their ongoing presence in Miami and West Palm Beach. They aren’t alone, the absence of a state income tax, coupled with a government that is business-friendly helped prompt hedge fund billionaires and native New Yorkers Paul Singer and Carl Icahn to relocate their firms to Florida.
Other prestigious firms have done the same; Blackstone opened an office in Downtown Miami in 2021. Citadel, relocated its headquarters from Chicago to Miami in 2021. D1 Capital Partners, a hedge fund, announced plans to relocate to South Florida in 2022. Merrill Lynch expanded its presence within Florida a bit sooner, 2020. Hedge fund, Tiger Global Management, announced plans to relocate to South Florida in 2022. In November of 2022, fund manager Ark Invest founded by Cathie Wood moved its headquarters out of NYC to St. Petersburg, FL. And the list goes on, and is growing.
In addition to lower costs of business, the areas these companies are moving to offer an educated base and a financially astute talent pool from which to hire.
And the financially savvy populous is getting deeper as professionals looking to relocate out of colder, high tax states, are moving down and becoming part of the already strong ecosystem. The ever-increasing depth of players include experienced attorneys, accountants, bankers, consultants, insurers, IT experts, and others with which to conduct world-class business dealings.
The other ingredients are here as well. Asset managers require convenient public and private executive airports. Local officials must also be conversant enough in their industry to regulate it intelligently, S. Florida checks both of those boxes too. It takes more than one large asset management firm to generate a demand for services sufficient to build the critical mass necessary to sustain an ecosystem. Florida has passed the tipping point and has already been labeled “Wall Street South.”
Florida Infrastructure
The ecosystem also includes facilities for tradeshows, networking events, and conferences. As an example, this coming December 3-5, Noble Capital Markets, a boutique investment bank located in Boca Raton, FL, will hold its massive, 19th annual investment conference, NobleCon19, at the 52,000 square foot, state-of-the art facility just opened on the Florida Atlantic University campus (FAU), in Boca Raton.
Noble’s 19th Annual Small-cap Investor Conference has been the “must-go” event in the area for 19 years. In 2023 the Noble can now expand this annual event into a facility that boasts the latest technology and conference facilities. This means investors and presenters at NobleCon19 will have an ideal setting to discover new opportunities and more room to welcome and network with the areas new financial executive neighbors, along with other attendees from across the globe.
From Good to Great
There are three defining factors that have helped the S. Florida region grow from an area with many small and mid-size financial firms to a strong and expanding financial center.
In no particular order, these include:
Greater reliance on virtual teams now makes physical proximity to key players less important . Even as many firms reel staff back into the office, companies are far more comfortable reaching team members virtually.
More associated professionals are moving to the emerging centers. When major investors and financial services giants such as Goldman Sachs, Blackstone, Citadel,Ark Invest, and Icahn Enterprises set up shop in a location, expertise follows. This is almost a requirement in sectors such as private equity, where deals are paved by personal relationships, social networks and professional networks.
The major cities in Florida already have existing professional and educational infrastructures. Of course, if the firms leadership is from out of town, it will naturally have a bias in favor of the schools they attended or are familiar with. But it is becoming easier to lose that bias when they learn that, for instance, in Palm County, Florida Atlantic University College of Business’ Executive Education just earned a prestigious global endorsement in the 2023 Financial Times rankings for open enrollment professional education programs – FAU ranked No. 2 in the United States.
Home Life
As one might imagine, with thousands of highly paid professionals looking for homes and “their new favorite restaurants” that real estate values are increasing and entire neighborhoods are becoming wealthier at every level. This growth feeds on itself and the improvements draw more top talent that then call South Florida the place they live and work.
Take Away
South Florida lost its reputation as a large retirement home where Grandma lives, and is now seen as an emerging financial powerhouse where big and small financial firms want to be to do business, grow their network, and live a better life.
With modern infrastructure, lower costs, top professionals, entertainment, and state of the art conference facilities, the trend is likely to continue.
Jan Hatzius Thinks the U.S. Will Avoid a Recession
The July hike in rates will be their last, according to a new forecast by Goldman Sachs’ chief economist, Jan Hatzius. In an analyst note dated July 17, Mr. Hatzius reduced his forecast for a recession over the next 12 months to only 20% from an already lower tha peers 25%, citing inflation that has dropped precipitously over the past year.
“We are cutting our probability that a US recession will start in the next 12 months further, from 25% to 20%,” Hatzius wrote. “The main reason for our cut is that the recent data have reinforced our confidence that bringing inflation down to an acceptable level will not require a recession.”
The forecast follows the previous weeks CPI and PPI reports that show both had decelerating price increases from previous periods, with consumer prices up just 3% from a year ago. The report pointed to a faster-than-expected decline in core inflation, which showed to a 4.8% increase from a year earlier. Core inflation readings don’t include food or energy prices that may be up or down based on factors unrelated to economic strength or weakness.
With inflation on the run, economists don’t expect the Fed to stop short of finishing the job. On July 25-26 next week the Federal Reserve is widely expected to adjust rates up another quarter-percentage point. Goldman’s Hatzius wrote he expects this will be the final increase in the Fed’s tightening cycle.
“We do expect some deceleration in the next couple of quarters, mostly because of sequentially slower real disposable personal income growth — especially when adjusted for the resumption of student debt payments in October — and a drag from reduced bank lending,” he wrote.
Monetary policymakers have raised interest rates sharply over the past year, approving 10 straight rate hikes in the span of one year to lower inflation that was as high as 9%. In a little over a year, the base overnight bank lending rate was pushed up from near zero to near 5.25%, the fastest pace of tightening since the 1980s. If Hatzius and many other economists are correct, Officials are expected to approve an 11th rate hike at the conclusion of their two-day meeting next week, the FOMC did not raise rates at the June meeting, choosing to assess the economy for a longer period before deciding.
Increased interest rates elevates costs on consumer and business loans, which then slows the economy by forcing employers to cut back on spending. Higher rates have helped push the average rate on 30-year mortgages above 7% from half that level a couple of years back. Borrowing costs for everything from home equity lines of credit to auto loans and credit cards have also spiked. This helps slow demand, less demand is less inflationary.
The labor market has remained strong despite the Fed’s assault on business conditions. Taken all together Goldman Sachs is more bullish on a soft landing for the US economy.
“The main reason for our cut is that the recent data have reinforced our confidence that bringing inflation down to an acceptable level will not require a recession,” he wrote. For context the average recession expectation has been 15% since WWII. Hatzius’ adjusted forecast is still above the average of 15%, but well below the median forecast on Wall Street, of 54%.
According to the note, encouraging CPI data is not a trend set to fizzle out, as fundamental signals highlight further disinflation to come, “Used car prices are sliding on the back of higher auto production and inventories, rent inflation still has a long way to fall before it catches up with the message from median asking rents, and the labor market has continued to rebalance with an ongoing downtrend in job openings, quits, reported labor shortages, and nominal wage growth,” wrote Goldman’s Hatzius.
Take Away
No economist has a crystal ball, but when Goldman Sachs issues a note, the markets pay attention. In its note this week it reports expectations that the odds of a recession in the next year have fallen to just 20%, citing encouraging economic data, including, employment, consumer sentiment and slowing inflation. Goldman’s senior economist expects just one remaining interest rate hike in the Federal Reserve’s tightening cycle, and that is expected in July.
On Friday, July 7, 2023, news broke in the financial market media that the “BRICS” (that is, Brazil, Russia, India, China, and South Africa) will implement their plan to create a new international currency for trading and financial transactions, and that this new currency will be “gold-backed”. Most recently, on June 2, 2023, the foreign ministers of the BRICS – as well as representatives from more than 12 countries – met in Cape Town, South Africa (interestingly at the “Cape of Good Hope”). Among other things, it was emphasized that they wanted to create an international trading currency. Undoubtedly, this is an undertaking that could have consequences of epic proportions.
After all, the BRICS countries represent about 3.2 billion people, approximately 40 percent of the world’s population, with a combined economic output nearly the size of the economy of the United States of America. And there are also many other countries (such as Saudi Arabia, United Arab Emirates, Egypt, Iran, Algeria, Argentina, and Kazakhstan) that might want to join the BRICS club.
The goal of the BRICS countries is to reduce their economic and political dependence on the US dollar, challenging “US dollar imperialism”. To this end, they want to create a new international currency for commercial and financial transactions, replacing the US dollar as the means of transaction unit.
The reason is obvious. The US administration has on many occasions used the greenback as a “geopolitical weapon” and engaged in a kind of “financial warfare”: Washington sanctions enemy countries by denying them access to the US dollar capital market, but above all, it shuts them off from the international US dollar-centric payment system.
The freezing of Russia’s currency reserves (the equivalent of almost 600 billion US dollars is currently at stake) has set off alarm bells in many non-Western countries. It has reminded a number of them that holding US dollars comes with a political risk. This, in turn, has prompted many to restructure their international foreign reserves: holding fewer US dollars, switching to other (smaller) currencies, but above all, buying more gold.
But how might the BRCIS manage to swim away from the US dollar? While no details are available yet about how the new BRICS currency might be structured, it should not stop us from speculating about what lies ahead.
The BRICS could establish a new bank (the “BRICS-Bank”), funded by gold deposits from BRICS central banks. The physically deposited gold holdings would be shown on the asset side of the BRICS bank’s balance sheet – and could be denominated, for example, “BRICS-Gold”, where 1 BRICS-Gold represents 1 gram of physical gold.
The BRICS-Bank can then grant loans denominated in BRICS-Gold (for example, to exporters from BRICS countries and/or to importers of goods from abroad). To fund the loans, the BRICS-Bank makes a credit contract with the holders of BRICS-Gold: The holders of BRICS-Gold agree to transfer their deposit to the BRICS-Bank for, say, one month, or one or two years, against receiving an interest rate. What is more, the BRICS-Bank, and it can also accept further gold deposits from international investors, who can hold (interest-bearing) BRICS-Gold deposits this way.
BRICS-Gold could henceforth be used by the BRICS countries and their trading partners as international money, as an international unit of account in global trade and financial transactions. Incidentally, the new de facto gold currency would not even have to be physically minted but could be and remain an accounting-only unit while being redeemable on demand.
The exporters from the BRICS countries and the other member countries would, however, have to be willing to sell their goods against BRICS-Gold instead of US dollars and other Western fiat currencies, and the importers from the Western countries would have to be willing and able to pay their bills in BRICS gold.
How do you get BRICS-Gold? Those demanding BRICS-Gold must either get a BRICS-Gold loan from the BRICS-Bank or purchase gold in the market and deposit it with the BRICS-Bank or a designated custodian, and the gold deposit is then credited to his account in the form of BRICS-Gold.
For example, in payment transactions, the goods importer’s BRICS-Gold deposits (held, for example, at the BRICS-Bank) are credited to the account of the exporter of goods (also held at the BRICS-Bank or at a correspondent bank or gold custodian).
However, the transition, the use of BRICS-Gold as an international trade and transaction currency, would most likely have far-reaching consequences:
(1.) It would presumably lead to a (sharp) increase in the demand for gold compared to current levels, with not only gold prices measured in US dollars, euros, etc. but also in the currencies of the BRICS countries increasing (substantially).
(2.) Such an increase in the gold price would devalue the purchasing power of the official currencies – not only the US dollar but also the BRICS currencies – against the yellow metal. Also, the prices of goods in terms of the official fiat currencies would most likely skyrocket, debasing the purchasing power of presumably all existing fiat currencies.
(3.) The BRICS countries would build up gold reserves to the extent that they run, or will run, trade surpluses. They would presumably be the winners of the “currency switch”, while the countries with trade deficits (first and foremost, the US) would lose out.
BRICS official gold holdings, in billion US dollars, Q1 2023
Source: Refinitiv; The BRICS’ gold reserves amounted to 5452.7 tons in the first quarter of 2023 (market value currently around 350 billion US Dollars).
These few considerations already show how disrupting the topic of “creating a new gold-backed international trading currency” could be: The BRICS could well trigger landslide-like changes in the global economic and financial structure. Still, it will be interesting to see how the BRICS countries intend to proceed at their August 22-24 meeting in Johannesburg, South Africa.
About the Author:
Dr. Thorsten Polleit is Chief Economist of Degussa and Honorary Professor at the University of Bayreuth. He also acts as an investment advisor.
Is the U.S. economy headed toward a soft landing? While rare, the numbers are beginning to argue in favor on the side of a soft landing versus a hard one. An economic soft landing is a situation in which the Federal Reserve is able to slow economic growth without causing a recession. A hard landing, on the other hand, is a situation in which the central bank’s efforts to slow down economic growth lead to a recession. Recent inflation reports, employment numbers, and economic growth figures are looking more and more like monetary policy over the past year and a half, may be defying past performance; the U.S. might be able to avoid a situation where the economy shrinks (negative growth).
Background
The Federal Reserve has been facing a difficult challenge for almost two years as inflation spiked well above the Fed’s 2% target. In fact increases in prices were at a 40-year high as inflation began to soar toward double-digits. Fed monetary policy, which effectively controls the money in the economy, that in turn impacts interest rates, has been acting to raise rates to bring inflation under control. Less money increases the cost of that money (rates), which dampens economic activity.
There has been, and continues to be, a risk that the Fed raises interest rates too high or too quickly, this is the hard landing economic path. The hard landing scenario is more common than soft landings.
The Federal Reserve has a miserable record of achieving soft landings. There have been a few occasions when the Fed has been able to slow down economic growth without causing a recession. One example of success is 1994-1995. During this period the Fed raised interest rates by 2.5% from a starting point of 4.25% in order to bring inflation under control. However, the economy continued to grow during this period, and there was no recession.
Today’s Scenario
The current state of the U.S. economy is uncertain. Inflation is at a 40-year high, and the Fed has been raising interest rates in an effort to bring it under control. However, there is a risk that the Fed will raise interest rates too high or too quickly, which could lead to an economic hard landing, with job losses and negative growth. In fact, after an FOMC meeting in November, Fed Chair Powell said it would be easier to revive the economy if they overtighten, than it would be to lower it if they don’t tighten enough. So to the Fed Chair, a hard landing is better than no landing at all.
There has been a high level of concern amongst stakeholders in the U.S. economy. One reason is that the U.S. economy is already slow. GDP growth in the first quarter of 2023 was 2.0%, and it is expected to slow in the second quarter. Maintaining growth while pulling money from the system to reduce stimulus is a difficult maneuver. In fact, it usually ends as a hard, undesirable economic landing.
Another factor that is of concern this time around is the state of the housing market. Home prices rallied with low interest rates during and post pandemic. A fall-off in housing would have a ripple effect throughout the economy, leading to job losses and lower consumer spending. So far, housing has held up as new home sales are strong, and demand for existing homes remains elevated as homeowners with low mortgage rates are deciding to stay put.
Where from Here?
On Monday (July 11), Loretta J. Mester, president and CEO of the Federal Reserve Bank of Cleveland, warned during an address in San Diego that the central bank may need to keep hiking rates as inflation has remained “stubbornly high.” Fed governors go into a blackout period on July 15 as they always do before an FOMC meeting. That meeting will be held on July 25-26. So there is no telling if the voting FOMC members are going to dial back their hawkishness in light of this week’s more favorable CPI report that shows yoy inflation at 3%.
The Fed’s favored inflation gauge is PCE. The next PCE report is not to be released until July 28, after the July FOMC meeting. The previous report showed that in May, inflation was running at 3.8% over 12 months.
The banking system, which showed some cracks back in March, seems to be shored up; although some problems still exist, a full-scale banking crisis does not seem likely. The Fed would obviously like to keep it this way.
Employment gains were the smallest in 2-1/2 years in June, however the unemployment rate is close to historically low levels and wage growth is still strong, so although wages are not fully working their way into the final cost of goods or services, the industries having to pay the higher wages are likely absorbing some of the cost, which could pull from profits.
Part of the Fed’s tightening has been the less talked about quantitative tightening. This reduces the Fed’s balance sheet which swelled as part of the reaction to the pandemic. Reducing this in a meaningful way will take time, but even if the Fed remains paused on rate hikes, there is still $90 billion scheduled to be pulled from the economy each month as maturities will be allowed to mature from the Fed’s holdings without being rolled. This my eventually cause U.S. Treasury rates and mortgage rates to tick up as increased Treasury borrowing, and decreased Fed ownership may put downward pressure on prices.
Take Away
The recent CPI report is causing some that argued a soft landing is achievable to celebrate and those that thought it impossible to consider it a possibility. The chances appear greater, and a soft landing is certainly a desirable outcome for stock prices and U.S. economy stakeholders. From here, there are a number of factors that can increase the risk of a hard landing, they include the pace of additional interest rate hikes, and the behavior of the housing markets. We’re entering a period where we will not hear any commentary from Fed governors, and the next major inflation indicator comes after the FOMC meeting, so markets will be on the edge of their seats until July 26 at 2 PM Eastern.
Statistically, 2023 Should Finally Be the Year for Small Caps
It has been six months since I shared the hard data and a graphic from Royce Investment Partners. In the firms most recent letter to investors, the firm reiterated the reality that after any consecutive five-year period where small-cap stocks had returned less than five percent, the following year, returns averaged 14.9%. Senior management of Royce again stated in its July newsletter, that a five-year low-performing period occurred 81 times in history, 81 times small caps had a sixth year with very good returns.
Are Small Cap Stocks on Track to Make it 82 Times in a Row?
The five-year period 12/31/83 through 6/30/23, was below 5% for each year. January kicked off the sixth year return was up over 5%. Since the strong January, we have had a strong June, and so far July. Year-to-date, the Russell 2000 index is up 9.4%, which is a strong six months – with six months to go. If it stays on course, small caps will keep the “100% of the time history.”
What is even more exciting is that in the month of June alone, the small cap index was up 6.9% and so far in July is up on the month and outperforming large cap indexes, which are all down on the month.
While a 100% of the time track record is comforting, the idea that so far only months that start with the letter “J” have been up, and after this month, we run out of “J” months, is concerning. The Royce newsletter dated July 7th has pointed out another positive statistic for where we are now.
Co-CIO Francis Gannon recognized, “It’s true that January and June were the only months so far in 2023 when the Russel 2000 had positive returns. There were four straight down months in between.” Gannon explained that this is also a rare occurrence that has occurred only nine times since the start of the Russell 2000 on the last day of 1978. The Co-CIO said, “For the eight periods for which we have data, subsequent one-year returns averaged 24.7%; subsequent three-year returns averaged 21.0%; and subsequent five-year returns averaged 16.8%.”
These numbers work on a simple, buy-the-dip phenomenom, but quantify it in a way that gives investors confidence that at a minimum there is a rationale behind expanding holdings in small cap stocks.
Take Away
Investing, at it’s core, is putting statistics on your side, expecting that it is not different this time, then letting historical probabilities play out. Large cap stocks are expensive compared to small caps. This may not be the only reason the two scenarios discussed in newsletters from Royce Capital Partners have played out. But other factors, including a rebalancing of the Nasdaq 100 Index this summer, strongly favor a more competitive performance of small cap stocks in 2023 than we have experienced in five years.
Cholesterol Efflux Mediator™ VAR 200 is in phase 2a development to reduce renal cholesterol and lipid accumulation that damages the kidneys’ filtration system in patients with glomerular diseases, including diabetic kidney disease, focal segmental glomerulosclerosis, and Alport syndrome
WESTON, Fla., July 07, 2023 (GLOBE NEWSWIRE) — ZyVersa Therapeutics, Inc. (Nasdaq: ZVSA, or “ZyVersa”), a clinical stage specialty biopharmaceutical company developing first-in-class drugs for treatment of inflammatory and renal diseases, announces that the European Patent Office granted a patent covering the company’s Phase 2a-ready Cholesterol Efflux Mediator™ VAR 200 (2-hydroxypropyl-beta-cyclodextrin) for use in diabetic nephropathy/diabetic kidney disease (Patent Number EP 2 836 221).
VAR 200 was developed in the labs of Dr. Alessia Fornoni, Katz Professor of Medicine, Chief, Katz Family Division of Nephrology & Hypertension, and Director of Peggy & Harold Katz Drug Discovery Center at the University of Miami. ZyVersa was granted an exclusive, worldwide, license for the development and commercialization of VAR 200 by L&F Research LLC, which was founded by Dr. Fornoni and others to obtain the intellectual property that had been released to the Inventors by the University of Miami.
“Approval of this patent claiming our Cholesterol Efflux Mediator™ VAR 200 for use in treating diabetic kidney disease speaks to the innovative and important research conducted by Dr. Fornoni and her team involving removal of excess cholesterol and lipids that damage the kidneys’ filtration system. There are no therapeutic options available that address this issue,” said Stephen C. Glover, ZyVersa’s Co-founder, Chairman, CEO, and President. “Strengthening our intellectual property portfolio for VAR 200 and expanding our patent protection and exclusive rights into additional geographic regions will further enable ZyVersa to increase shareholder value as VAR 200 advances into clinical trials, which are planned for initiation in the fourth quarter of this year. There is a tremendous need for effective treatments to slow progression of renal disease.”
About Cholesterol Efflux Mediator™ VAR 200
Cholesterol Efflux Mediator™ VAR 200 (2-hydroxypropyl-beta-cyclodextrin, 2HPβCD) is a phase 2a-ready drug in development to ameliorate renal lipid accumulation that damages the kidneys’ filtration system, leading to kidney disease progression. VAR 200 passively and actively removes excess lipids from the kidney.
Preclinical studies with VAR 200 in animal models of FSGS, Alport syndrome, and diabetic kidney disease demonstrate that removal of excess cholesterol and lipids from kidney podocytes protects against structural damage and reduces excretion of protein in the urine (proteinuria).
The lead indication for VAR 200 is orphan kidney disease focal segmental glomerulosclerosis (FSGS). VAR 200 has potential to treat other glomerular diseases, including orphan Alport syndrome and diabetic kidney disease.
About ZyVersa Therapeutics, Inc.
ZyVersa (Nasdaq: ZVSA) is a clinical stage specialty biopharmaceutical company leveraging advanced, proprietary technologies to develop first-in-class drugs for patients with renal and inflammatory diseases who have significant unmet medical needs. The Company is currently advancing a therapeutic development pipeline with multiple programs built around its two proprietary technologies – Cholesterol Efflux Mediator™ VAR 200 for treatment of kidney diseases, and Inflammasome ASC Inhibitor IC 100, targeting damaging inflammation associated with numerous CNS and other inflammatory diseases. For more information, please visit www.zyversa.com.
Certain statements contained in this press release regarding matters that are not historical facts, are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These include statements regarding management’s intentions, plans, beliefs, expectations, or forecasts for the future, and, therefore, you are cautioned not to place undue reliance on them. No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. ZyVersa Therapeutics, Inc (“ZyVersa”) uses words such as “anticipates,” “believes,” “plans,” “expects,” “projects,” “future,” “intends,” “may,” “will,” “should,” “could,” “estimates,” “predicts,” “potential,” “continue,” “guidance,” and similar expressions to identify these forward-looking statements that are intended to be covered by the safe-harbor provisions. Such forward-looking statements are based on ZyVersa’s expectations and involve risks and uncertainties; consequently, actual results may differ materially from those expressed or implied in the statements due to a number of factors, including ZyVersa’s plans to develop and commercialize its product candidates, the timing of initiation of ZyVersa’s planned preclinical and clinical trials; the timing of the availability of data from ZyVersa’s preclinical and clinical trials; the timing of any planned investigational new drug application or new drug application; ZyVersa’s plans to research, develop, and commercialize its current and future product candidates; the clinical utility, potential benefits and market acceptance of ZyVersa’s product candidates; ZyVersa’s commercialization, marketing and manufacturing capabilities and strategy; ZyVersa’s ability to protect its intellectual property position; and ZyVersa’s estimates regarding future revenue, expenses, capital requirements and need for additional financing.
New factors emerge from time-to-time, and it is not possible for ZyVersa to predict all such factors, nor can ZyVersa assess the impact of each such factor on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Forward-looking statements included in this press release are based on information available to ZyVersa as of the date of this press release. ZyVersa disclaims any obligation to update such forward-looking statements to reflect events or circumstances after the date of this press release, except as required by applicable law.
This press release does not constitute an offer to sell, or the solicitation of an offer to buy, any securities.
Corporate and IR Contact: Karen Cashmere Chief Commercial Officer kcashmere@zyversa.com 786-251-9641
As the Fear Index Screams Upward, It’s Worth Noting It is Still Near It’s 2023 Low
Suddenly, the Volatility Index or VIX, is trending. While the month of June showed extremely low volatility in stocks, the FOMC Minutes on July 5th lit a fuse on investors during a relatively low-volume holiday trading week. Whether the VIX level increases or remains elevated from here remains to be seen, but it is important to understand what it usually indicates, what it does not, and how traders use the CBOE’s Volatility Index.
The VIX, short for the Chicago Board Options Exchange Volatility Index, is a measure of market volatility. It is calculated based on the prices of S&P 500 index options, and it is often referred to as the “fear index” because it tends to rise when investors are feeling more fearful about the market. It reached its low point of the year (-40%) on June 22nd as volatility has been trending down since the start of Spring. While it bounced in dramatic fashion this week, it is important to note that this is a thinly traded week, and the index is still -29% YTD.
The VIX index is a derivative instrument that is widely traded. By some, to hedge portfolio risk, by others to speculate on the direction of stock market volatility. According to the CBOE, it is “a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index (SPX).” The CBOE uses prices in the SPX Index (S&P 500) with short expiration dates, then it generates a 30 day projection of how quickly prices may change, which is volatility. It is often called the “fear index” as volatility shows a more erratic market that both stems from fear and produces fear.
The Index is not a perfect predictor of market activity, but it can be a useful tool for investors. It is important to remember that the VIX index is based on options prices, and options prices can be volatile themselves. As a result, the VIX index can sometimes give false signals.
How is it Used
Investors use the VIX index in a number of ways. Some investors use it to gauge the overall level of risk in the market. Others use it to help them decide whether to buy or sell stocks. And still others use it to hedge their portfolios against market volatility.
To gauge the overall level of risk in the market. The VIX index is a good way to get a sense of how worried investors are about the market. A high VIX index indicates that investors are feeling more fearful, while a low VIX index indicates that investors are feeling more confident.
Some investors use the VIX index to help them decide whether to buy or sell stocks. If the VIX index is high, they may be more likely to sell stocks, as they believe that the market is likely to be volatile. If the VIX index is low, they may be more likely to buy stocks, as they believe that the market is likely to be stable.
Investors can use the VIX index to hedge their portfolios against market volatility. For example, they can buy VIX futures or options to smooth returns or protect themselves from losses if the market becomes more volatile.
It is important to remember that the VIX index is not a perfect predictor of market activity. It is based on options prices, and options prices can be volatile themselves. As a result, the VIX index can sometimes give false signals. However, the VIX index can be a useful tool for investors who are looking to get a sense of the overall level of risk in the market and to help them make informed investment decisions.
Take Away
The Vix Index is off its low for the year, it was reached in late June. The speed at which it rose this week may caused fear, but the move could be exaggerated by a holiday-shortened thinly traded week in the markets. There does however seem to have been a change in thinking among the securities markets. U.S. Treasury rates out in the longer periods rose after the FOMC minutes were released. The stock market for months has been viewing good economic news as bad and bad economic news as good. The minutes, coupled with an employment report this week indicate a still strong economy. The stock market was wishing for weak economic reports as participants feared higher Fed induced interest rates.
Whether the new sentiment among bond traders holds remains to be seen. If it does, the yield curve will take on a normal slope. Will a positively sloping curve be viewed by stock market investors and those that believed the inverted curve indicated a recession as bullish? Time will tell.
The Markets During the First Half of 2023 Were Reflective of the People that Trade Them
Financial markets reflect the collective actions and expectations of market participants. This includes rational analysis, irrational emotions, and at times less than rational analysis. The emotions and number crunching get their cue from a daily barrage of information including: profits, policy, panic, prices, politics, purchasing power, the president …and that’s just the Ps. So each day, as Channelchek prepares to deliver research, articles, and pertinent video content to subscriber’s inboxes, we plow through an abundance of information and hope to share what is either not being addressed or covered, or present front page news from the point of view of seasoned investors, not less experienced news writers.
Below are six articles, one from each month this year. Although I have favorites not included here, and these may not have been the most read or shared, they told a slightly expanded story than found on the mainstream take on the subject and are still relevant to some investors.
As a content provider to this popular investment research platform, my job is not to call the market; it is to present thoughts and knowledge to help investors make decisions on small and microcap stocks along with the overall universe of investment opportunities. The insights below from earlier this year are still quite current, and worth digesting.
On the very first business day of 2023, three regulators announced concerns over businesses involved in cryptocurrency citing the lack of oversight, lack of standards, and unknown risk. As the year progressed, the three federal agencies, which do not include work on oversight being done by the SEC or CFTC, are now working hard to regulate what banks can do involving crypto. The SEC for its part has been creating headaches for some of the larger crypto exchanges. Banks are having a particularly difficult time incorporating the asset in their business.
Investment content providers love Michael Burry. The reason is that readership goes through the roof whenever his name is mentioned. Still, if there is nothing to write about the subject, or if it is old news, the writer, blogger, or vlogger is doing investors a disservice.
We’re choosy about when to take one of Burry’s rare tweets and decipher them for readers. But, we always try to be among the first when his fund’s public holdings are reported each quarter on SEC form 13-F. But there are only few times during the year when there is actually worthwhile news. This is because Burry is usually tightlipped. Unless required by a regulator, the successful hedge fund manager is out of the public spotlight, presumably crunching numbers and rebuilding old guitars.
This article is good advice that can be used any time the Fed is trying to reel in inflation.
It was 1963 the last time the CFA Institute (Chartered Financial Analyst) made any changes to their prestigious designation. However, the investment world is changing, and the CFA Institute is responding in order to better serve those that benefit from the services of skilled analysts. In 2023 CFA candidates will have more choices, more study material available, and the ability to take credit for their rigorous studies beginning after passing Level I.
Some thoughts on why, eligibility, and the new focus are presented here along with how it should help keep the credential fresh and more useful.
It wasn’t too long ago that the Federal Reserve did not announce its intentions. If a Fed-watcher or market participant wanted to know for certain if the FOMC adjusted monetary policy, the best they could do is see if measures of money supply increased or decreased. Weeks later the FOMC Minutes would be released, and the markets would know for sure what the Fed did at the previous meeting.
When the Fed became more transparent, the market focus on money-supply disappeared. This has now reversed as the stimulative money that had been injected into the economy to prevent undue weakness during the pandemic is now being methodically removed via quantitative tightening (Q.T.). The renewed focus on M2 is to make sure the Fed sticks with its plan. Signs that it may not be impact the amount of money available to chase goods and services, this impacts inflation.
The Fed’s battle to drain the cash put into the system, and do it in a way that doesn’t crash banks, or the overall economy is perilous, is continuing and well worth understanding.
Economists and news writers have been negative about the economic outlook, scaring people with the word recession since before the year even began. And while there are some weaknesses, the stimulative money supply is still exceedingly high, jobs are more abundant than workers, and home sales have not reacted as expected when mortgage rates rise from 3% to 7%.
The often-repeated line that the downward slope of the yield curve is a time-tested indicator of an impending recession was the echo chamber talking point that probably didn’t apply to this economy because of a novel Fed policy.
From a textbook position, those saying a negative yield curve indicates a recession got the answer right if they were taking a college quiz. However, those that were saying this inverted yield curve indicates a recession may have flunked. And if you copied off the economist next to you, and they somehow missed that the Fed owned 33% of all U.S. Treasuries outstanding, and because of their policy of yield-curve-control, the yield curve was not market-driven, and therefore not a reliable indicator of anything. What we know is that when the Fed buys one out of every three bonds, it leaves a mark on the area of the curve that they are active.
With higher than expected GDP released last week, most have stopped talking about a recession in 2023. We put out several articles beginning in 2022 explaining why others may have this yield curve indicator wrong, this is addition is most recent.
I highly recommend reviewing this article if your summer backyard barbecues include conversations about economic strength (or weakness).
Small Cap stocks had been lagging behind larger companies. Historically they are more volatile, but investors expect to be compensated over time for the additional risk they take. Yet, over a longer than normal period, they still lagged. This seemed to have changed; during the first week in June there were some days that small company returns had a little more giddy-up than they had in recent months or years. On June 6th we published the above article.
Small cap stocks finished the month well ahead of the large caps and even mega-cap companies. This momentum has carried into the second half.
Let’s Start the Second Half of 2023 Together
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I hope you found these six articles compelling, and if you have not registered for no-cost insights to your inbox each day, here’s your chance to start the second half with a slightly different investment angle.
This Week’s Focus Will be Defining More Precisely What the Fed’s Bias Is
A holiday-shortened week, coupled with the expected lighter trading volume, has the potential to create a situation where markets or individual stocks overreact to news, then stock prices settle back closer to the starting point after a short period. This is a bigger than normal risk on Wednesday, the first regular trading day of the week, as the Federal Reserve releases the FOMC minutes from the June 13-14 meeting.
Monday 7/03
• * Abbreviated trading session US markets. NYSE 1 PM close, US bond market 2 PM close.
• 9:45 AM ET, The final Manufacturing PMI for June is expected to come in at 46.3, unchanged from the mid-month advanced read. This is below 50 and indicates significant contraction.
• 10:00 AM ET, The ISM Manufacturing Index has contracted for the last seven months. June’s consensus is 47.3 which would be a slight increase from May’s 46.9.
• 10:00 AM ET, Construction Spending for May is expected to continue to rise by 0.5 percent. This follows a strong 1.2 percent in April.
Tuesday 7/04
• * Independence Day USA. Markets and government offices closed.
Wednesday 7/05
• 10:00 AM ET, Factory Orders are expected to rise 0.9 percent in May versus April’s 0.4 percent gain. Factory Orders are a favorite leading indicator of many economists when determining if the activity is likely to pick up or slow.
• 2:00 PM ET, FOMC Minutes from the most recent meeting when the Fed left rates unchanged will be poured over by Fed watchers and market participants to evaluate any bias beyond what is already known.
• 4:00 PM ET, New York Federal Reserve president John C. Williams is the President will be speaking. Williams serves on the Federal Open Market Committee; his addresses reflect the Fed’s Twelfth District’s perspective on monetary policy.
Thursday 7/06
• 7:30 AM ET, Challenger Job Cut Report was 80,089 in May. The monthly report counts and categorizes announcements of corporate layoffs based on mass layoff data from state labor departments.
• 8:45 AM ET, Lorie Logan is the President of the Dallas Federal Reserve, she will be giving an address pre-market opening.
• 9:45 AM ET, The PMI Composite Final is expected to confirm advanced reads of the purchasing managers survey.
• 10:00 AM ET, JOLTS, the report on job openings is expected to read 9.9 million for May. The PMI Composite Final is expected to confirm advanced reads of the purchasing managers survey. April’s 10.103 million was much higher than expected and pointed to strong resilience in labor demand.
• 11:00 AM ET, EIA Petroleum Status Report (EIA) provides weekly information on petroleum inventories in the US, whether produced here or abroad. The level of inventories helps determine prices for petroleum products.
Friday 7/07
• 8:30 AM ET, Employment is expected to have risen 213,000 for nonfarm payroll in June versus 339,000 in May, which was much higher than expected. Average hourly earnings in June are expected to rise 0.3 percent for the month with a year-over-year rate of 4.2 percent; these would represent very little change. June’s unemployment rate is expected to hold unchanged at 3.7 percent.
• 11:00 AM ET, EIA Petroleum Status Report (EIA) provides weekly information on petroleum inventories in the US, whether produced here or abroad. The level of inventories helps determine prices for petroleum products.
What Else
This is a popular vacation week among professional traders and investment managers. Any direction that may seem to take shape may not have legs as the month progresses.
Happy Independence Day to the United States; may it have many more.
