Moving The Goalposts / What Inflation? / Andrew Carnegie / UFC 245: Cooperman vs. Warren? / GSE Update: Calabria at American Action Forum

Moving The Goalposts

In Kaoboy Musings 5 (10/3/19), I posed the question: “Is ‘bad’ once again ‘good’?”  I was referring to the notion that “bad” economic data might be interpreted positively by the market on the notion that a once hawkish Fed might be convinced to become accommodative in the face of economic weakness.  After last week’s FOMC meeting on 10/30/19, I opined in Kaoboy Musings 11 that the Fed overtly tied its future policy stance to a 2% inflation bogey, which I thought was significant.  On the one hand, Powell showed his cards already with respect to his “downside playbook,” after 3 cuts to the Fed Funds rate year-to-date; ergo, “bad” is “good.” 

But what was most significant about last week was that Powell also revealed his “upside playbook” by dispelling the converse theory that “good” is “bad,” that strong economic data would lead to a hawkish response and a swift return to tightening.  In fact, by this line of reasoning, when the jobs number came out last Friday (11/1) and showed a whopping 128k addition to payrolls versus the 85k consensus (lowered due to the GM strike), not to mention strong upward revisions of previous months, one might have expected a negative market reaction over fear of a Fed policy whipsaw.  Instead, the market ripped to new highs.  By moving the upside goalposts to an inflation target rather than, say, strong employment numbers or GDP growth, Powell all but admitted to a patiently accommodative Fed policy stance and summarily exorcised the “good”-is-“bad” bogeyman.  So now, at least from a Fed policy perspective, “bad” is “good” but “good” is also “good.”

 

What Inflation?

The two charts below show the current state of inflation in the U.S., or lack thereof.  The left shows the CPI (Consumer Price Index), and the right shows the PPI (Producer Price Index); both are popular barometers for inflation rates.  Both indicators display strong downtrends in the short-term – despite strong concerns that the tariffs would result in higher consumer prices.  While tariffs have impacted certain industries, they are just not causing inflation in the aggregate.  My hunch is that this is the strong USD at work, “importing” weakness from abroad, which is why I am supportive of the Fed easing – if only to arrest the relentless surge of the USD. 

Over the long-term (see chart below), we have not had significant, sustained CPI increases (>5% per annum) since Blondie had the top song (“Call Me”) on the billboards in 1980 (technically, the CPI didn’t break down below 5% until almost 1983, but 1980 marked the peak)!

Clearly, something else has kept inflation subdued for decades.  Most would point to technological innovation as the secular culprit, and I would agree – we have seen this before.  Paraphrasing Mark Twain, “history may not repeat itself, but it often rhymes.”

 

 Andrew Carnegie

One of the books I am currently reading is the fascinating biography of Andrew Carnegie by David Nasaw (hat tip to Bob Lesko for the great recommendation).  On the one hand, this “rags-to-riches” tale extols the virtues of the “American Dream” made possible by capitalism: how a poor immigrant boy from Scotland began his career as a “bobbin boy” in a cotton factory and stair-stepped his way  from industry to industry, eventually becoming one of the most prominent industrialists and philanthropists of America.  On the other hand, it also paints a dark side to the fully unregulated capitalism of the day, showing how a complete lack of government protections against trusts/price-fixing led to rampant crony capitalism and a very uneven playing field, often causing violent clashes between corporations and unions. 

Most interesting, however, was the fact that throughout Carnegie’s lifetime, technological innovation was the one constant that kept exerting a deflationary force on the economy.  The widespread adoption of the power loom cost Carnegie’s father (a handloom weaver) his job and forced the family to emigrate to America.  Throughout Carnegie’s steel career, inexorable advances in steel-making technology like the Bessemer process constantly created efficiencies that increased productivity but exerted downward pressure on wages.  If this happened over 100 years ago, imagine what is happening today in a global, cloud-connected society with AI/machine learning advances every other day. 

Ergo, “good” is now “good” from a Fed policy perspective now that the goalposts have been moved to “sustained inflation above 2%.”  Good luck with that, Jerome.  I’m guessing other economic measures will run hot before this measure -- I believe that this will be a concern at some point, but I think we have a ways to go due to all of the aforementioned reasons in past Kaoboy Musings for why this economy still has slack in it, despite an ebullient and arguably overbought stock market in the shortr-term. 

 

 

UFC 245: Cooperman vs. Warren?

Talking about Andrew Carnegie and the “American Dream” is a perfect segue to the current war of words between Democratic hopeful Elizabeth Warren and retired hedge fund manager Leon (“Lee”) Cooperman on the topic of wealth inequality – an issue as germane today as it was back in Carnegie’s day. 

While I’m generally going to steer clear of politics in this newsletter, I am a truth-seeker at heart and have enclosed a copy of his recent open letter to Warren, because I think Lee does a phenomenal job of cutting through the political snarks and offers a well-reasoned defense of our successful, capitalism-based economy.  I have known Lee a long time and have always respected his thoughtful, balanced views. 

  

 In particular, Lee’s distinction between “income opportunity” vs. “income inequality” on page 4 of his letter resonated with me.   His list of countries with the lowest Gini coefficients (measures of income equality – the lower, the more “equal”) included Afghanistan, Albania, Algeria, Kyrgyzstan, Moldova, Romania, Slovakia, Slovenia, and Ukraine.  To quote Lee:

 ”Yet despite the relatively high degree of financial equality implied by their numbers, none of these countries can boast booming economies or generalized income and wealth-creation opportunities.  It would therefore appear that their citizens may be more aligned than those of most other countries in the fair distribution of wealth, but that does not translate in any meaningful sense into widespread prosperity.”

 In my opinion, this letter is worth a read no matter what your political persuasion is, because it not only invites thoughtful two-way, bipartisan discussion (is this even possible anymore?) on the hot topic of wealth inequality, it also offers pragmatic, viable solutions versus some of the blatantly confiscatory ideas floated by politicos that are more pandering than practical.  

Our society has come a long way from the “Wild, Wild West” of Carnegie’s day – we have antitrust laws, we have securities laws against trading on inside information, we have regulations in all kinds of industries that protect both the consumer as well as the employee.  Yet our economic system stands almost uniquely in the world in terms of the widespread creation of opportunity and wealth because we’ve managed to preserve the “secret sauce,” which in my opinion, is the capitalistic impulse that says if you create a product or service that is deemed valuable by society, there is (almost) no theoretical limit to where you can go with it.  I believe we must never lose sight of that – no matter who is in the Oval Office.

 

 

GSE Update: Calabria at American Action Forum

 

GSE Preferreds (see Kaoboy Musings 1) have been drifting lower in recent weeks, likely due to lack of near-term catalysts.  There is some truth to this, although I’m somewhat inured to this given my 11-year hold so far.

FHFA Director Mark Calabria spoke today at the American Action Forum.  Here are some quick soundbites which I found interesting.

  1. Calabria emphasized that staying in conservatorship is NOT an option and that exit from conservatorship does NOT depend on Congress.  On this last point, he called this dependency on Congress a “myth” and said he “won’t wait for Congress to authorize him to do something he’s already been authorized by Congress to do.”
  2. Rather, it is FHFA’s statutory mandate to EITHER 1) get the GSE’s out of conservatorship, OR 2) put them into receivership.  Significantly, he followed up with this comment: “I want to emphasize that the conditions for receivership are not here today.”  This is exactly what I conjectured in Kaoboy Musings 9 after so many news outlets latched onto Calabria’s comment that “receivership was still an option.”  Sure, it’s an option, but it’s no longer a relevant option.
  3. He worries that a certain “complacency” has developed around conservatorship and hopes to keep the momentum going on “administrative and regulatory reform,” saying that “hopefully this time around we can do this before a crisis.”  Channeling JFK, he quipped, “The time to repair a roof is when the sun is shining.
  4. I thought it was interesting that he said that getting the GSE’s out of conservatorship and back into private hands would “depoliticize mortgage finance reform.” 
  5. He summarized the recently released Strategic Plan from FHFA as having 3 main objectives:
    • Have the GSE’s foster a liquid, competitive mortgage finance market
    • Remind the GSE’s to operate in a “safe and sound condition,” making sure no “conservatorship complacency” sets in
    • Prepare the GSE’s for exit from conservatorship
  6. With the breathing room of the recently relaxed Net Worth Sweep requirements to allow for $45 bn of capital buildup (vs $6 bn previously), they now have 4-5 quarters of time to restructure the agreement with Treasury
    • This gives them time to get the GSE’s ready for exit
    • This gives them time to get the FHFA ready to be the post-conservatorship regulator
    • Mentioned that the exit is process-driven rather than calendar-driven (this may be why the market may seem disappointed at a lack of near-term catalysts)
  7. Perhaps most significantly, at the end of the speech, he said that if he were a future creditor to the GSE’s, he’d want to see “a whole lot of equity beneath him” and said that that is exactly what their goal is.  

And herein lies the crux of my thesis: if the goal is to have a “whole lot of equity” in the capital structure, can you accomplish this by eviscerating the old equity and then tell would-be investors to trust them?  I say no.

  

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

Powell’s Dove Transformation

 

Powell's Dove Transformation

I just listened to the Fed press conference, and my take is that Chairman Powell has decidedly turned dovish. 

Even though he re-emphasized that the recent reserve additions should not be construed the same way as the longer-term Treasury purchases of QE, Powell made it very clear that the 2% inflation target is what he is most concerned about.  The USD (as measured by the DXY which I cited yesterday) initially spiked on worries of a “hawkish cut” – that Powell was going to cut one last time and then re-affirm vigilance on when to go back to a hiking stance.  Instead, Powell said that “we are not immune to disinflationary pressures from around the world” and would not look to hike again unless there were sustained signs of a resurgence of inflation.  I think this is very significant.  To me, it shows that Powell understands the concern of a too-strong USD importing economic weakness from abroad and is willing to stay accommodative and even let the economy run a bit “hot” before the next hiking cycle.

The DXY immediately reversed course on this statement:

 

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

Mid-Earnings Season Gut-check/ Black Gold About to Shine? / King Dollar No More?

Mid-Earnings Season Gut-check

As of 10/29/19, a little over half of the S&P 500 have reported Q3 results.  I found it interesting that out of 10 major industry sectors represented, all 10 sectors had positive earnings surprises, 6 had positive sales surprises, and of the 4 that had sales disappointments, only 1 group (Utilities) had a negative surprise that exceeded 1%!  The second worst sales disappointment came from the Materials sector with a -0.90% sales surprise, but the earnings beat was a whopping 7.8%.  This seems to corroborate my thesis that the economy has strong bones despite the constant “wall of worry” that this economic expansion is “long in the tooth.”

In fact, the “wall of worry” is more than just nervous rhetoric; as I mentioned in some past Musings, this economy has seen a number of bursting mini-bubbles that, in my opinion, keep the overall market in check. 

Here are a couple of recent examples of carnage on my own “Bubblicious Watchlist”:

  • WeWork, one of the private equity “unicorns,” appears to be really just a donkey – spectacularly crashing from a peak valuation of $47 bn to a “rescue” valuation of ~$7 bn.
  • Beyond Meat (BYND), having hit a mid-year peak of ~$240/sh, lost 22% in one day to end at $81.99 on 10/29/19 as its lockup expired, proving that its valuation was “Beyond Believable.”
  • GrubHub (GRUB) caused some hubbub also on 10/29/19 as it plunged 43% in one day to $33 – a far cry from the $149 peak reached a little over a year ago. 

In my view, despite the pain this has caused a relatively narrow slice of market participants (like Softbank), these bursting “bubblets” remove a lot of speculative froth in the market and greatly reduce the chances of a market-wide rout a la 1999-2000.  As a “value” guy, I am optimistic that this may herald a shift out of the high-multiple/high-growth “go-go” names and into the low-multiple, “boring” names that have been left by the wayside. 

Black Gold About to Shine?

Speaking of sectors left by the wayside, there is no bigger dog than the Oil & Gas sector (represented by the XOP in red), as evidenced by the chart below, which shows 11 different sector-specific ETFs alongside the SPY (S&P 500) in white, all normalized to a starting value of 100 at the beginning of 2019. 

Truth be told,  this underperformance has held true over the last 5 years ever since crude oil collapsed from ~$115/bbl at the end of 2014.  In short, a combination of cheap money plus a huge wave of technological innovation in hydraulic fracturing has created a surfeit of cheap oil, which has allowed the U.S. to surpass Saudi Arabia in oil production for the first time in decades. 

I feel like a broken clock when I say this, but I believe the U.S. “shale miracle” will not last forever and that we will see a return to significantly higher oil prices in the not-so-distant future – even without Elizabeth Warren’s frac-ban coming to fruition. 

My thesis goes something like this:

Capital discipline, which was lacking, has returned to the U.S. shale space.  From 2015 to now, the U.S. shale space has seen dozens of bankruptcies and consolidations.  Given the abysmal performance of this sector, the capital markets have all been shut except to the lowest-cost operators in this space.  Even the lowest-cost operators have “found religion” and become rational players in terms of focusing on living within free cash flow – this is a huge departure from the “outspend at any cost” attitude that pervaded the industry just 3-5 years ago.  As a result of this newfound capital discipline, rig counts are at multi-year lows (see below), where the blue line denotes 2019. 

Meanwhile, Saudi Arabia desperately needs to get oil prices higher.  Despite the oil bromance between Saudi Arabia and Russia, OPEC+ has been unable to lift oil prices out of the doldrums due to the confluence of U.S. overproduction over the last several years along with global growth concerns due to the trade war. 

In 2018, oil creeped back into the mid-$70’s as the production cuts seemed to be working at the same time Trump’s sanctions hit Iranian production.  That all changed when Saudi Crown Prince bin Salman was implicated in the murder of the journalist Khashoggi, and Trump leveraged this against Saudi by insisting that they open the floodgates to make up for the lost Iranian production.  Then, just as these Saudi barrels were en route, Trump gave waivers to several countries (after he had threatened no waivers) – this is what caused the December of 2018 rout in crude oil from $75 to $45. 

Since then, crude oil has rebounded to the mid-$50’s.  Why is this a problem for Saudi Arabia?  Aren’t they the lowest cost producer in the world?  Yes, but the issue is that the social programs the Saudi government put in place since the Arab Spring require $85-$90 oil for fiscal breakeven, and they have been hemorrhaging for years.  Little wonder that the much-anticipated Saudi Aramco IPO has been postponed multiple times already.  Perhaps the third time is the charm, and this time they will really go public this year.  But then that begs the question: why would Saudi want to sell even part of their crown jewel, unless 1) they really need the money, or 2) maybe they know something we don’t about the longevity of their oil fields? Incidentally, their primary Ghawar field has been producing since 1951.

Finally, I should mention that crude oil has historically exhibited an inverse correlation with the USD, because it is the most important, USD-denominated commodity in the world.  See below (white is a USD index called the DXY, and orange is crude oil):

In addition to all the aforementioned fundamental reasons why I think oil is about to move higher, this relationship adds another technical reason – I believe that the USD is about to weaken, and that weakening will add more fuel to a potential oil rally (pun intended).

The chart below shows what happened to our yield curve once our Fed Chair turned dovish.  What a difference a month (and a couple “Non-QE” QE Fed moves) makes.  This chart shows the yield curve on 10/29/19 (green) and 9/27/19 (yellow) – the recession indicator (inverted yield curve) that has successfully forecast 10 out of the last 3 recessions seems to have sputtered away. 

King Dollar No More?

While a slightly lower Fed Funds rate by itself won’t do a whole lot to stimulate the economy, what I think is far more significant is that it prevents the USD from becoming too strong and importing economic weakness from abroad.  Remember that ~20 central banks around the world are easing despite the world being awash in $17 trillion of negative-yielding sovereign debt.  Referencing  Kaoboy Musings 7, I believe this has more to do with long-term, structural/demographic headwinds that afflict other countries much more so than the U.S.  Yet in a globally interconnected economy, the lodestone of super-low interest rates around the world will manifest in an inexorably strengthening USD, which would make our exports relatively less attractive and thus “import” economic weakness from abroad – unless we too join in the easing cycle, at least enough to arrest this spiral. 

My last chart below zooms in on the DXY (previously shown to be inversely correlated with oil), which is basically an index of the USD against a basket of major world currencies;  note that the recent swoon coincides almost exactly with Jerome Powell’s metamorphosis from “hawk” to “dove.”

Here’s the bottom-line of all this:

  1. I think the market may be shifting out of “bubblicious” names and into “value.”
  2. There is no “value” sector that’s as beaten up as the oil and gas space.
  3. There are several fundamental reasons why oil (and oil stocks) may be poised to move higher.

That, coupled with the Fed’s dovish stance, may add USD weakness as further fuel for an oil rally.

 

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

Update on Fannie/Freddie

Update on Fannie/Freddie

It’s been a while since I’ve opined on the GSE’s (see Kaoboy Musings 4 - 9/30/19), so here is a quick update. Here is quick summary of recent events:

  • 10/4/19:   FHFA announces intention to hire external financial/restructuring advisors to come up with a plan for recapitalization.
  • 10/10/19: Calabria gives interview at “Meet the Policymakers Forum” at George Mason University
  • 10/22/19: Mnuchin/Calabria/Carson testify before the House Financial Services Committee on the future of the GSE’s

Summary of House Financial Services Committee testimony on 10/22/19

Yesterday, the House Financial Services Committee held a hearing entitled, “The End of Affordable Housing? A Review of the Trump Administration’s Plans to Change Housing Finance in America.”  I listened to all 3.5 hours of committee members grilling Mnuchin, Carson and Calabria, and once again, I’m not surprised that it was 95% partisan, grandstanding “noise,” especially given the title of the hearing.  In short, it was a tough crowd. 

Calabria reiterated in his opening remarks that Fannie and Freddie, in their current form, would not survive another financial crisis given the lack of capital cushion.  He noted that in his first 6 months as FHFA Director, he’s halved the GSEs’ leverage ratio from 1000:1 to 500:1 by allowing the combined capital cushion to expand from the razor-thin $6 bn to $45 bn (see Kaoboy Musings 4).  That said, he reiterated that the entities require a lot more capital to get them capitalized similarly to banks which have 10:1 leverage ratios.  Both Mnuchin and Calabria testified that the GSEs would need to (and be able to) raise significant external financing.

While both Mnuchin and Calabria testified that their first priorities were to “shore up” these entities financially, they both treaded very carefully to not appear overtly shareholder-friendly.  If anything, they went the other way to assuage committee members who were hostile to the “recap and release” plan potentially enriching shareholders and hedge funds -- by repeatedly saying that no decisions have yet been made regarding the method of resolution, i.e. recap and release out of conservatorship or exit via receivership. 

I believe this mention of “receivership,” however alarming it sounds, is nothing more than a red herring.  The comment that the alarmist financial press latched onto was Calabria’s statement that “if circumstances present [themselves] where we have to wipe out shareholders, we will.”  Yet what all of the media/sell-side analysts seem to have already forgotten is that one of the primary plaintiff assertions that the 5th Circuit recently upheld was that the FHFA can be either conservator or receiver and that it already chose the path of conservator in 2008 even though it has proceeded with actions more consistent with receivership (i.e. Net Worth Sweep). 

Here are some key passages from the 5th Circuit decision:

Page 7:

FHFA is not just a regulator. Under 12 U.S.C. § 4617 it may serve as conservator or receiver for the GSEs. FHFA has discretion to appoint itself conservator or receiver in some cases, and receivership is mandatory in other critical insolvency situations.25 Conservatorship and receivership are mutually exclusive: Appointing FHFA as receiver “shall immediately terminate any conservatorship established for the regulated entity under this chapter.”

Page 9:

Section 4617 grants some powers to FHFA as conservator only:

Powers as conservator

The Agency may, as conservator, take such action as may be—

(i) necessary to put the regulated entity in a sound and solvent condition; and

(ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity.33

It grants other powers to FHFA as receiver only:

Additional powers as receiver

In any case in which the Agency is acting as receiver, the Agency shall place the regulated entity in liquidation and proceed to realize upon the assets of the regulated entity in such manner as the Agency deems appropriate . . . .34

Page 11:

In September 2008, FHFA appointed itself a conservator for the GSEs. The next day, Treasury and the GSEs entered Preferred Stock Purchase Agreements.

Pages 12-13:

The Third Amendment replaced the quarterly 10% dividend with variable dividends equal to the GSEs’ entire net worth except a capital reserve. The Shareholders call this arrangement the “net worth sweep.” The capital reserve buffer started at $3 billion. It decreased annually until it reached zero in 2018. This arrangement was a double-edged sword. The GSEs no longer struggled to make dividend payments, but they would also no longer accrue capital. Treasury also suspended the periodic commitment fees. Treasury announced that the Third Amendment would “expedite the wind down of Fannie Mae and Freddie Mac” and ensure that the GSEs “will be wound down and will not be allowed to retain profits, rebuild capital, and return to the market in their prior form.” A federal official commented privately that the Third Amendment was designed to prevent Fannie and Freddie from recapitalizing.

Near the end of the hearing, AOC probed Mnuchin on whether he had anything to gain financially from a recap and release, to which Mnuchin replied an emphatic “no,” stating that he had divested all public holdings as a precondition to accepting his role.  Calabria ended by stating that his role as FHFA Director legal requires him to free the GSE’s from conservatorship, even though “Wall Street” doesn’t like the prospect of increased competition.

Having watched more of these hearings over the last 11 years than I care to admit, I think the Mnuchin/Calabria/Carson triumvirate did exactly what I expected them to do: 1) reiterate their mandate to protect the taxpayer as well as the affordable housing mandate, 2) distance themselves from enriching shareholders and hedge funds (especially with an election year coming up), and 3) remain non-committal on next steps.  In fact, I believe FHFA’s announcement earlier this month that it is seeking to hire an external financial/restructuring advisor is exactly such an insulating move.

At the end of the day, I believe that both Mnuchin and Calabria understand that receivership would 1) endanger the capital markets and economy, 2) almost definitely invite new Constitutional “takings” claims, and 3) likely face an uphill legal challenge at the SCOTUS given that HERA itself mandates the FHFA to be either conservator or receiver but not both and that the FHFA already chose the path of conservatorship (at least in name) 10 years ago.  So when Calabria stated that he would “wipe out shareholders if the circumstances present themselves” and that he’d wished for receivership in 2008, I think he’s telling the truth but carefully omitting the fact that those “circumstances” under which receivership might have been a viable option have long since expired. 

Summary of George Mason University Interview on 10/19/19

I also went back and listened to the George Mason University interview on 10/10/19, and I thought that the stance was far less curated to mollify hostile congresspeople, i.e. there was far more “signal” and less “noise” in this forum. 

Calabria emphasized that his legal mandate as FHFA Director was to get the GSE’s out of conservatorship, and that the prerequisite for the exit was “9-18 months” of retaining earnings.  He reiterated that, given his belief that we are potentially “late in the [housing] cycle” albeit with a strong equity market, he felt that now is a perfect time (over the next 1-3 years) for the GSE’s to tap the external markets for capital. 

When queried on how to incentivize new private capital given sub-par returns the businesses currently generate while in conservatorship, Calabria said:

“We are spending a fair amount of time internally looking at a whole menu of options to raise Fannie and Freddie’s ROE’s going forward…I do recognize that to build capital, they have to be attractive…We have made changes that we think have already boosted the ROE relative to conservator capital…Just keep an eye on the business, and you’ll see margins that change.”

Interestingly, he also gave some historical context on why the HERA language (which he had a part in developing) closely resembles the verbiage governing the FDIC’s bank resolution powers – they were very wary of putting in new receivership language that would invite “takings” claims, hence they defaulted to precedent. 

Finally, he hinted that the negotiations with the Treasury around the PSPA should be done by “middle of next year,” and that they’re driven less by time-line than by “getting the sequencing right.”  He said that he expected the hiring of an external restructuring advisor to be done by November. 

Here is a distillation of my thesis on the GSE preferreds over the last 11 years:

How did we get here?

  • Fannie and Freddie are systemically important, with a guarantee book of $5.6 trillion.
  • Due to their TBTF (Too Big To Fail) status, the Paulson Treasury of 2008 put them into conservatorship to supposedly forestall a crisis of confidence by essentially making the previously “implicit” guarantee “explicit.”
  • Ironically, as a result of conservatorship, Fannie and Freddie had to take massive write-downs of deferred tax assets, which generated massive amounts of accounting losses, which then “required” the “taxpayer bailout” of $190 bn of senior preferred being inserted into the capital structure carrying a 10% dividend.  This is an angle that no reporter has covered.
  • Curiously, just as Fannie and Freddie were about to turn the corner on profitability, net of the 10% dividend to the senior preferred, the Geithner Treasury of 2012 replaced the 10% dividend with the Net Worth Sweep (NWS), which sweeps all profits to Treasury ad infinitum except for a razor-thin $6 bn combined capital margin. 
  • Now that we are 11 years post-conservatorship and almost 8 years post-NWS, Treasury has swept $310 bn into its coffers without deeming one penny of the $190 bn of senior preferred liquidation preference as repaid.

What is prompting a change now?

  • Eleven years into this expansion, there is a growing concern that this particular housing cycle is near a peak.
  • With liabilities of nearly $6 trillion and a capital base of $6 billion, Fannie/Freddie are 100x more levered than banks.  With the relaxation of the NWS last month, Fannie/Freddie will now be allowed up to $45 billion of capital.  
  • While this is an improvement, I think the GSE’s will require $250-$500 bn of capital to place them truly in sound financial condition on par with the banks. 
  • The only way for Fannie/Freddie to raise another $200-$450 bn of non-taxpayer capital while still preserving the 30-year mortgage and not disrupt the housing market is to recapitalize these entities by enticing new private capital.

What will incentivize new private capital to step in?

  • A demonstration and commitment that private capital cannot be taken without compensation – which is what the conservatorship/NWS have done.
  • Reassurance that contingent liabilities (i.e. all the shareholder lawsuits) have been cleaned up.
  • A clear path to profitability and return on equity.

What are the likely steps (in my humble opinion) required to get from A to B?

  • End the NWS – this has been done only partially thus far, due to the $45 bn cap.
  • Deem the senior preferred liquidation preference repaid, even if it first has to be adjusted up for the retroactive, explicit cost of an explicit government guarantee.  Could this number be $200 bn? $250 bn?  $300 bn?  I get the distasteful political optics of paying shareholders back (even though it is the shareholders who have been wronged), but without the elimination of this liquidation preference and the consequent settling of myriad lawsuits, I do not see how or why any new private capital would want to step in.
  • Crystallize the business plan going forward such that shareholders know the cost of the explicit guarantee as well as their ability to raise their guarantee fees to a level that gives an adequate return on equity.
  • Only after all of these conditions are met, can the entities go on the road and pitch a new offering.

At the end of the day, I believe the “signal-to-noise” ratio has always been very low in these Congressional hearings due to political pandering.  The George Mason University testimony provided far more informational content on FHFA’s true intentions, in my opinion. 

My thesis is unchanged.

 

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

So far, so good, so what? / China Musings / What-The-Frac?? / Book & Show Reviews

So far, so good, so what?

 

Lots going on since my last missive (Kaoboy Musings 7, 10/7/19). Here’s a recap:

  • U.S. and China entered into a tentative “Phase 1” deal:
  • Fed announced “QE 4” despite calling it “not QE”
  • Inflation data remains subdued with PPI/CPI both coming in near zero
  • University of Michigan Consumer Sentiment Index significantly beat expectations: 96 vs 92
  • Housing starts came in slightly weaker (1256k vs 1320k)
  • Initial jobless claims came in as expected (214k vs 215k)
  • Q3 earnings season has started on a strong foot with companies like JP Morgan, Morgan Stanley, and Netflix all handily beating expectations

As my subject header suggests (hat tip to Megadeth as I borrowed an album title), so far, so good – I interpret this mix to be a “Goldilocks brew,” where the data are not bad enough to warrant recession concerns but not strong enough to warrant a hawkish Fed.  Although the devil’s always in the details (hence the “so what?”) when it comes to any agreement with China, this “Phase 1” deal signifies a significant thawing of tensions at the very least.  At the same time, the Fed’s “not-QE QE” is an admission that perhaps the Fed got a little ahead of itself in terms of withdrawing liquidity from the system (causing among other things a rip-roaring USD and a sharp, technically induced spike in overnight repo rates to 10% on 9/17/19) and is moving to reverse that.  It’s not surprising to me that since the beginning of October, the USD index (as measured by DXY) has weakened 2%, and the S&P 500 has rallied about 2%

 

China Musings

I’ve been reading quite a bit about China (see below for my reading list), as I’ve wanted to better understand Xi’s true motivations.  Here are a couple takeaways:

  1. Xi is cut much more from Mao’s autocratic/state-centric cloth than from Deng’s decentralized/“free market” cloth.  Since Xi came to power in 2013, he has aggressively adopted a heavily nationalistic “Chinese Dream” agenda where he has closed off China’s markets to the world (in heavy contrast to the Deng-inspired decades of Jiang Zemin and Hu Jintao) while simultaneously paying lip-service to being a champion of globalization on the world stage.  At the same time, he has deftly used the mantle of “anti-corruption” to purge the Politburo of his adversaries, and in 2018, Xi pulled a “Palpatine move” by abolishing China’s longstanding two-term limit for the Presidency.
  2. The increasing strength of China’s SOEs (state-owned enterprises) along with their use by the government as arbiters of state policy will continue to distort world markets unless China is strongly economically disincentivized.  China’s top-down, “command-and-control” economy is very effective at getting things done fast; however, it is very ineffective at finding optimal market equilibria versus a free-market, capitalist system.  As I discussed in past Musings, I believe China’s biggest state directive is to foster rapid urbanization in a bid to increase per-capita GDP and outrun its demographic timebomb (see Kaoboy Musings 7).  As a result, the state has employed millions of people in industries it deems to be strategic priorities: steel, cement, solar cells, EVs, etc.  In almost every single case, this directive has produced massive economic distortions in those markets until the resultant overcapacity (in some cases of over 50% as in steel and cement) forces a response either internally or externally.  I believe that Xi’s much-touted “One Belt One Road (OBOR)” initiative to essentially rebuild the Silk Roads of old via a modern network of railways, pipelines and maritime routes is yet another state directive that is going to produce massive economic distortions around the world.
  3. China’s Sopranos-style shylocking methods in its international dealings is increasingly being recognized as a new form of “colonialism” and will severely hamper its bid to become a global hegemon.  On the surface, China’s OBOR initiative is incredibly impressive: $5 trillion to be spent in thousands of infrastructure projects around 60+ countries.  For developing nations in Africa and in Central Asia, the lure of Chinese money seems irresistible – until these countries realize that they’ve signed deals with the Devil.  A case in point is the Hambantota Port of Sri Lanka, where China knowingly lent Sri Lanka more money than it could repay and then forced Sri Lanka to cede the port to China on a 99-year lease.  A strategically brilliant and ruthless move by China – but it makes the U.S.’s foreign entanglements seem downright altruistic.  In the long-term, I believe practices like these make it impossible for China to compete with the U.S. from a soft power perspective.

In short, China is short on natural resources and long on human labor.  While it makes eminent sense to engage in this kind of arbitrage (and the OBOR initiative does just that), I believe China’s state-centric worldview is fundamentally flawed and cannot compete with the capitalistic system of efficiently apportioning resources in the long-term.  Furthermore, its brazen loan-sharking methods will backfire, in my humble opinion.

 

What-The-Frac?

There have been some recent announcement by politicos to ban all hydraulic fracturing activities in the U.S.  While I try to avoid partisan discussions in my Musings, I do try to bring contrarian perspectives to “mainstream” views.  While I get that the extraction and subsequent use of any fossil fuel ignites the ire of environmentalists and climatologists around the world, I believe the mainstream discussion largely ignores the “what-if” scenarios that would occur worldwide if fossil fuels (and frac-produced fossil fuels to a lesser extent) were eliminated outright.

 

I read an eye-opening book last year entitled The Moral Case for Fossil Fuels that addresses exactly this discussion void.  Alex Epstein, the author, very convincingly debunks a lot of myths regarding fossil fuel use and makes the case (with a lot of supporting evidence) that:

 

  1. Fossil fuel use has greatly improved human quality of life for billions.
  2. The Earth has been on a consistent warming trend since the dawn of the Industrial Revolution – long before significant carbon emissions could have possibly been an influence.
  3. Most climate models have been grossly inaccurate (i.e. not even close) in their predictions.
  4. Outside of nuclear, fossil fuels remain as the most efficient generator of energy for humankind.
  5. There is much to-do about developing battery technologies (forget about the environmental impact of this) to enable widespread use of intermittent sources of energy like wind and solar – nature has already produced the most efficient battery, and it is called the hydrocarbon.

In short, he is not arguing against global warming nor is he denying that carbon emissions contribute to global climate change; rather, he makes the case that 1) the mainstream discussion regarding whether or not to eliminate fossil fuels from our energy diet largely revolves around inadequate theories that fossil fuels are the primary determinant of climate change (as opposed to long geologic eras of climate change that are inexorable), and 2) that it is not fair to single out the shortcomings of fossil fuels without simultaneously considering the positive contributions (cheap, abundant energy for billions).

There is a great YouTube debate where the author Alex Epstein debates a well-known climatologist named Bill McKibben:

I would encourage those with open minds to watch this debate and read this book – as always, I’m interested in devil’s advocacy and would love to hear your opinions afterward.

Shale oil (what hydraulic fracturing produces) currently accounts for ~60% of total U.S. oil/gas production of around 11 mm barrels/day.  Shale oil has enabled the U.S. to supplant Saudi Arabia as the world’s largest oil producer since September, 2018 and has enabled the U.S. to become a significant exporter of oil for the first time in decades.  I just read a research report from energy specialist Tudor, Pickering and Holt that estimated that world oil prices would spike to $85-$130/barrel on a sustained basis without U.S. shale oil (oil currently trades at $54/barrel).

I’ll end this segment with a provocative question: what will $100 oil on a sustained basis do to the world economy not to mention the already energy-starved population of billions in the developing world?

 

Book & Show Reviews

My recent reading list:

The New Silk Roads by Peter Frankopan

Was a bit disappointing vs. Frankopan’s first book, The Silk Roads.  The first third of the book gave some interesting insights on how China’s “One Belt One Road” initiative is influencing development in the Central Asian countries (the “-stans”: Kazahkstan, Turkemistan, Kyrgyszstan, Uzbekistan, Tajikistan, Afghanistan, and Pakistan).  Unfortunately, the next two-thirds of the book devolved into a highly partisan tirade, which is a turn-off to me in any book.

The Third Revolution: Xi Jinping and the New Chinese State by Elizabeth Economy

I thought this was a very, no-nonsense depiction of Xi Jinping’s rise to power, how his worldview was heavily influenced by Mao vs. Deng and explains why perhaps there is rare bi-partisan support for trade policies that stand up to China – when the “carrot” strategy doesn’t work, sometimes you have to use the “stick.”  Fascinating to see the motivations behind China’s “One Belt One Road” initiative as well as some of the consequences.

The Moral Case for Fossil Fuels by Alex Epstein

See discussion above.  I found this book to be very provocative and eye-opening in many ways.

My recent watch list:

Inside Bill’s Brain: Decoding Bill Gates on Netflix

I thought this 3-part series was great despite the mixed reviews it got.  I would’ve liked to see a bit more coverage on his Microsoft years, but overall, it did a decent job of introducing the audience to Bill’s childhood influences as well as showing how his focus has evolved from aggressively competing for world domination to aggressively pursuing big philanthropic initiatives through the Bill & Melinda Gates Foundation.

 

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

Noise, Demographics & Why We Need Lower Rates

Noise, Demographics & Why We Need Lower Rates

My one-word summary of the week: NOISE. 

The U.S. is banning visas on certain Chinese officials?  Risk-off!  The Chinese are open to a partial deal? Risk-on!  Having been a professional money manager for most of my career, volatility-inducing headlines like these used to make me lose sleep – literally.  Now that I’m mostly managing my own money and not overly concerned about monthly mark-to-market performance, I find it somewhat easier to cut through the noise and focus on what I consider to be bigger picture trends.

What I heard this week through all the noise was that the Fed has turned decidedly dovish and is expanding its balance sheet once again – just don’t call it QE!  Okey dokey, Jerome.  In the same interview, he also echoed  some of my own musings that while there may be “bubblets” here and there, there simply is no evidence of an all-encompassing “irrational exuberance,” and therefore the economy “still has significant room to run” (paraphrasing here).

Regardless of whether you agree with this or not (I agree), I think this is significant coming from the Fed Chair.  The primary argument I hear from bears is essentially this: “the Fed is pushing on a string,” “companies aren’t going to hire/spend more just because interest rates are 0.50% lower,” etc.  Respectfully, I think this argument misses the crux of the issue – the USD is just too strong vis-à-vis most world currencies and will continue to strengthen if the Fed does nothing.  Why?  Because at least 20 central banks around the world are easing to combat their own fiscal/structural issues. 

Quick digression on these structural issues – I think the big albatross around everyone’s necks is demographics.  Why on earth are central banks around the world continuing to ease when the world is already awash in $17 trillion of negative-yielding debt?  Again, zooming way out from the day-to-day minutia, I think the primary issue the developed countries are facing is an aging population, and this factor more than anything else is going to drive the global economy in next several decades.

Barron’s ran an excellent cover story several weeks ago about this demographic time bomb, and I’m going to borrow 2 of their exhibits (see below).

The first exhibit on the left is pretty self-explanatory – the world’s population mix is getting older.  Japan’s post-WWII Baby Bust shows exactly what happens economically as a result of this effect – tepid growth for decades despite perennially low rates. 

The exhibit on the right really startled me.  The caption is hard to read, so I repeat it here: “The time it takes for people over 60 to grow from 10% to 20% of the population.”  The U.S., with a population of around 330 mm, takes 75 years to reach this milestone – although we have a looming Social Security problem, we’ve arguably had enough time to build the societal infrastructure required to handle this shift.  China (population: 1.4 bn) and India (population: 1.3 bn) have far shorter timeframes to deal with a much more massive population shift.  While we here in the U.S. face structural issues of our own, there is far more slack in the system -- we have far more land and resources with a quarter of the population, and we have a far higher rate of immigration (although it’s debatable whether this helps or hinders our structural issues). 

China and India are going to face huge structural headwinds on this front.  Not only are they far more populous, they are also short the resources that we are naturally long: food, water, and oil.  In this context, it makes sense that the Chinese Communist Party is hell-bent on stimulating its economy through urbanization and the creation of a viable middle class – they are truly racing against the clock.  The adage that “China is going to grow old before it grows rich” rings somewhat true to me, and this further bolsters my case (see Kaoboy Musings 5) that China has the much weaker hand in this trade war.  End of digression.

So now that we’ve established a potential why for the seeming nonsensicality of negative yields around the world, I go back to why an accommodative Fed is important.  If we do nothing, and the rest of the world continues to ease, we are actually tightening economic conditions through the strengthening USD, which will effectively import economic weakness from abroad.  I believe this is why the Administration has been lambasting the previously hawkish Fed – I agree with the call for lower rates, but I don’t condone the lambasting. 

 

In short, this is why I’m still sanguine on the U.S. economy.  Now that we’ve had a whiff of economic slowdown in the numbers, the Fed has morphed from hawk to dove, and now that the Fed is no longer “in the way,” we are no longer boxing China with one hand tied behind our back.  This strengthens our hand in the negotiations, and with an upcoming Presidential Election in 2020, I predict that the Administration will incentivize China to do a deal sooner than later. 

 

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

Goldilocks Jobs Friday

Goldilocks Jobs Friday

And now for the Big Kahuna Economic Number of the Week: 

The US added 136k jobs, and the unemployment rate fell to 3.5% from 3.7%, a 50-year low.

To me, this sounds like a “Goldilocks” number — not so high so as to turn the Fed “hawkish,” not so low so as to damage fundamentals.

Last night, I attended a panel on the state of the economy with a room of smart folks representing a broad swath of the economy, ranging from manufacturing to services. My big takeaway is that while there is still a fair bit of PTSD from the Great Recession and angst over the current “longest expansion ever,” there was inconclusive evidence of a broad-based slowdown; in fact, in individual discussions afterward, I heard about as many “bullish” data points as I heard “bearish.”  

My thesis is that we have a broad, diversified economy akin to a giant cruise ship — it’ll take a Titanic-sized iceberg a la 2008 to sink us, and while there are many small icebergs here and there, it’s tough for me to see The Big Kahuna on the horizon, especially when we have a 50-year low in unemployment.

I really don’t think I’m whistling past the graveyard and being a blind Pollyanna, saying “this time it’s different.”  While there are definite mini-bubbles here and there (private equity, media/streaming, etc.), there are equally many mini-busts (crypto, cannabis, energy, etc.).  I would be much more worried if  everyone was gung-ho on everything and uniformly seeing “clear skies ahead” than the current environment where CEO’s seem to be cautious in containing costs and NOT over-investing in capacity simply because we are into uncharted territory with respect to the length of the expansion. I say that the  intensity of expansion matters (or lack there of), and the tepid growth of most of the last decade suggests to me that this particular expansion takes the shape of a very long and shallow “U” rather than the “V” we saw leading up to the past several crashes.

To paraphrase a famous stormtrooper, “this is not the ‘irrational exuberance’ we are looking for.” 

TGIF!

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

Is “bad” once again “good”? / Check mate China, part deux

Is "bad" once again "good"?

It’s been a week of pretty weak economic data. Notables:

10/1       ISM Manufacturing 47.8 vs 50 expected

               Construction spending .1% vs .5% expected

10/3       Initial Jobless Claims 219k vs 215k expected

               ISM Non-Manufacturing Index 52.6% vs 55% expected

As I mentioned in one of my last Musings, although the economy has been slowing, I remain optimistic that we are not going into recession in the near-term.  In my humble opinion, the economy has strong bones and that the two primary drags on our growth are 1) trade worries, and 2) dollar strength due to  domestic interest rates still being too high relative to the rest of the world.  This article does a good job articulating why the obstacles are mainly coming from without vs. coming from within:

https://www.wsj.com/articles/for-a-change-its-the-world-that-is-pulling-down-the-u-s-economy-11570021741

Why am I sanguine amidst a sea of doom and gloom?

  1. After a lot of hemming and hawing, the Fed finally gets it and has turned accommodative again.  After 2 cuts year-to-date, odds of a third cut before year-end just went up to 92% today after the weak ISM data.  Today’s market price action also suggests that a bit of a “sell-the-rumor/buy-the-fact” bounce may be forthcoming, as “bad” (economic data) may once again be interpreted as “good” (at least for the markets).  Importantly, an accommodative Fed directly addresses the dollar strength issue outlined above.  It may be a race to the bottom in terms of competitive currency devaluation around the world, but my biggest concern over a formerly tone-deaf Fed was that continued USD strength would effectively import economic weakness from other countries.  Hopefully, Powell is “on the case” now and will prevent that.
  2. Trade of course is the wildcard, but I think economic weakness at home and abroad will increase the chances of some kind of resolution.  I’ve always figured that it would be part of Trump’s playbook to be initially very hawkish on trade – to the tune of forcing the Fed to become accommodative (which it now has) – and then get a deal done before 2020 elections. 

Check mate China, part deux

There are some who think China holds all the cards in this trade battle because 1) they have the luxury of a long-term perspective vs. our 4-year Presidential cycles, 2) they have virtually unlimited stimulus options given their “command and control” political/economic system.  Once again, I hold a contrarian view here.  Here is a post I put on LinkedIn a couple months ago:

I may be in the minority on this, but i don't think this "trade war" is going to hurt us that much besides some CPI increases – hell, the Fed has been TRYING to gin CPI above 2%! China, however, is screwed though.

What can China do to us?

Not buy more goods? Oops, they already sell $500 bn more than they buy.

Tax our car imports? Oops they're already at 22.5%.

Not buy our pork? Oops they just lost 1/3 of their herd.

Not buy our soy/food? Oops they're short on food, we are long.

Not buy our oil? Oops, WTI trades $10 lower than Brent and is the cheapest oil in the world.

Not allow our internet search? Oops they never let GOOG in.

Not allow our e-commerce? Oops they never let AMZN in.

Not allow our social media? Oops they never let FB in.

Oh right, they have the nuclear option – they can dump our tsy's. Oops, with 2’s/10’s flat, our yield curve could USE some steepening. Our banks would love that.

Check mate, China.

The only thing that’s changed above is that WTI now “only” trades $5.50 cheaper than Brent.  But what else has changed?  Weeks upon weeks of violent rioting in Hong Kong – I believe this is a real-time referendum on China’s policies from their own people.  Not only do I believe that Xi’s bargaining leverage began weak relative to us, but his leash is getting shorter with economic weakness stoking civil unrest. 

Furthermore, I think China is stuck between a rock and a hard place with respect to its currency.  For years, China has benefited from linking its RMB to the perennially weak USD, which artificially super-charged its exports – much like the same way Germany benefited from replacing the Deutschmark with the Euro which has been artificially weakened by the southern European countries.  Now, China finds itself stuck the other way – linked to a relatively strong USD; this, coupled with tariffs, should put a “double-whammy” on their exports. 

So why not devalue?  They’ve already relaxed the peg somewhat, but if they just let the peg go, they would risk major capital flight.  But can’t they just clamp down with capital controls?  Sure, but then the Hong Kong conflagration extends to Shanghai, Beijing and everywhere else.  In this scenario, the Communist Party itself would face an existential threat imho.

Again, check mate, China.

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

Fannie, Freddie Permitted to Boost Capital Cushions by Billions

Fannie, Freddie Permitted to Boost Capital Cushions by Billions

So the world was watching Calabria’s Twitter feed last night with bated breath, and this is what we got:

https://twitter.com/markcalabria/status/1178404592775766017?s=21

Funny guy – the comments are even funnier! 

Thankfully, Treasury/FHFA followed it up this AM with the real deal (see article below) and officially ended the Net Worth Sweep after 7 years of stripping these capital structures bare.  They are now allowed to retain up to a combined $45 bn of capital (up from the de minimus $6 bn).  This was very well-telegraphed into the market, so I don’t expect any trading fireworks from this alone; nevertheless, IT IS A BIG DEAL. 

It means that Treasury/FHFA are serious about allowing the GSE’s to retain capital, and ending the Net Worth Sweep is a necessary precondition for what must come after if the goal is to eventually build enough capital cushion to compete with banks.  I estimate this number to be close to $150 bn- $200 bn – a number that can only be reached by raising new private capital, and I’ve maintained for the last 11 years that one can’t raise new private capital if one eviscerates the old private capital (our junior preferreds). 

What happens next?  I see today’s announcement as a big first step to a more comprehensive plan.  There was no mention today of the senior preferreds, but I expect this liquidation preference of $190 bn to be increased (I’m guessing ~$250 bn) to compensate Treasury for the cost of an explicit guarantee over the last 11 years.  But then I expect that they will deem this number fully repaid, since Treasury has already swept ~$310 bn during conservatorship. 

Next, I expect Treasury/FHFA to settle the myriad outstanding shareholder lawsuits, especially now that the recent 5th Circuit decision gives shareholders significant judicial momentum.  The writ of certiorari I opened about in my last email adds additional pressure by bring this matter before the SCOTUS. 

Finally, when the capital structures and shareholder lawsuits are cleaned up, I expect Treasury/FHFA to commence the capital raising part.  This is unlikely to happen until end of 2020 at the earliest, coinciding with the Presidential election.  I expect that the Trump Administration will tout the successful recapitalization as a political win: “preserving the 30-year mortgage and home affordability for the masses.”

Stay tuned…

Meanwhile, here is an article about this:

Fannie, Freddie Allowed to Boost Capital by Billions

 

 

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.

Market Musings / GSE Gyrations / Book Recommendations

 

Market Musings

It’s been an interesting week on a number of fronts. Markets chopped around and ended generally on a weaker note, likely due to the following factors:

  • Impeachment concerns around the Ukrainian controversy
  • Lack of progress on China trade talks and new talk of limiting investment flows into China
  • Weak market reception to the high-profile Peloton IPO (not to mention the shelving of the WeWork IPO)
  • A 20% drop in Bitcoin, as yet another barometer of “risk off” sentiment in speculative instruments
  • A collapse of oil prices back to pre-Saudi attack levels due to earlier-than-anticipated restoration of output as well as rumors of easing Iran sanctions
  • Continued collapse of streaming stocks like NFLX and ROKU

In my humble opinion, none of these factors are terminal to this market, and I find myself somewhat in the minority these days in terms of believing that the economy remains in decent shape and that a recession is not imminent.  Anecdotally, I generally hear that business fundamentals remain strong (if not gangbusters) amongst my peer group – even as there is a generally pervasive “wall of worry” of imminent recession simply due to the duration of the current expansion.  Although manufacturing has slowed appreciably due to trade concerns, the consumer remains strong, the Fed has become accommodative again, and I believe there will be a trade resolution prior to 2020 elections. 

The duration of the expansion does not concern me because the intensity of the expansion for the bulk of this 11-year period has been very tepid – although there are certainly bubbles in sub-sectors of the market, I simply don’t see an atmosphere of “irrational exuberance” across-the-board.  Picture yourself stretching one of those resistance bands at the gym – as long as you’re not holding this pose with maximum tension, you can probably hold the pose for a very long time.  That is how I see this economy currently.

In fact, as a “value investor,” I would say there are as many pockets of cheapness and value as there are of “giddiness” – the energy sector, for instance, is at multi-decade lows in terms of valuations.  Last I checked, market busts aren’t usually heralded by relatively healthy business and economic fundamentals coupled with “wall of worry” concerns that inherently stymie overconfidence and overcapacity – it’s usually exactly the opposite mix of these factors that we need to worry about.

  

GSE Gyrations

Enough macro talk, and onto some “micro” talk about my current favorite investment idea – the Fannie/Freddie preferreds. 

Although the market awaits the “Big Kahuna End of Net Worth Sweep” press release with bated breath, nothing has hit the tape yet.  I got some questions as to why these got hit earlier in the week only to rally back by end of week.  First, let me say that as an 11-year holder of these securities, I’m about as inured to volatility in these as I believe the market has become inured to impeachment talk!  

Nevertheless, my best explanation for the initial selloff is that impeachment concerns engendered a “risk off” move in the markets and these prefs specifically because the recapitalization plan is generally a Trump Treasury/FHFA-backed plan.  Certainly, a successful impeachment of Trump or a Trump loss in 2020 has the potential to slam these – although I’ve opined in the past that the market reality of unwinding the GSE’s will prove unpalatable to any Administration.

Then, on Wednesday, the plaintiff attorneys in the Collins case that recently “won” the 5th Circuit decision filed an unexpected writ of certiorari to the Supreme Court, which I read to accomplish the following:

  1. It attempts to preempt a remand/appeal by the Defendants and accelerates the timing of an outcome, creating max pressure for the Treasury/FHFA to settle
  2. It opens a new battlefront directly to the SCOTUS by attempting to insert the Plaintiffs’ assertion (that the FHFA is unconstitutionally structured) in front of the highest court because of another case before the SCOTUS regarding the constitutionality of another regulatory body, the CFPB
  3. It still keeps the option alive in the lower courts

Bottom-line: this was an unexpectedly aggressive tactic coming from the Plaintiffs, but one that is very smart in my opinion. 

Book Recommendations

Lastly, because I’m a huge fan of Charlie Munger’s idea that one must have “multiple mental models” to be a good investor, I’m going to share some periodic book reviews/synopses from my admittedly eclectic reading list. Here are a couple of my favorites of the year so far:

Endurance: Shackleton’s Incredible Voyage by Alfred Lansing

Incredible true account of Ernest Shackleton’s doomed expedition to Antarctica in 1914 and the amazing story of grit, leadership and the will to survive against seemingly impossible odds.  Very engrossing and quick read.

The Silk Roads: A New History of the World by Peter Frankopan

I read this earlier this summer en route to the heart of Turkey for our family summer trip.  I generally like to read something topical to where we visit, and this was a phenomenal book about the importance of geography.  Of particular interest to me (due to my trip) was how and why Constantinople held such an important role in world history due to its geographic position straddling Europe and Asia.

Prisoners of Geography by Tim Marshall

Continuing down this theme of the importance of geography, I found this gem of a book which takes you around the globe and frames age-old conflicts and modern geopolitics in geographical terms. Fascinating to see how geography plays a huge role in a lot of current world conflicts like Russia/Ukraine, India/Pakistan, the instability in the Middle East, etc.

The Happiness Curve: Why Life Gets Better After 50 by Jonathan Rauch

Although I’m not yet 50, I guess I’m already prepping for it!  This is somewhat of a dense read, but I found it fascinating nonetheless.  In short, the author cites clear statistical evidence that happiness follows a U-shaped curve, starting off high during youth when “the world is your oyster,” declining into middle-age ostensibly due to unrealistic expectations gaps as well as biological reasons, and then rounding the corner and going back into the highs thereafter – surprisingly even in infirm old-age situations.  Apparently, this pattern generally holds true across geographies, ethnicities – and even in other primates.  To my middle-aged friends – we all have something to look forward to!

‘Til next time…

 

Copyright

© 2019-2020 Akanthos Capital Management, LLC. All rights reserved. Protected by copyright laws of the United States and international treaties. This website may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), in whole or in part, is strictly prohibited without the express written permission of Akanthos Capital Management, LLC.

About

Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets.  I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.

Disclaimer

Akanthos Capital Management, LLC (“Akanthos”) is an exempt reporting investment adviser with the state of California.  This message is for informational and professional purposes only, cannot be distributed without express written consent, and does not constitute advice, an offer to sell, or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities.  The contents of this message should not be relied upon in making investment decisions.  The information and statistical data contained herein have been obtained from sources that we believe to be reliable but in no way are warranted by us as to accuracy or completeness.  The accompanying performance statistics are based upon historical performance and are not indicative of future performance.  The types of investments discussed do not represent all the securities purchased, sold, or recommended for clients.  You should not assume that investments in the securities or strategies identified and discussed were or will be profitable.  While many of the thoughts expressed in this message are stated in a factual manner, the discussion reflects only Akanthos’ beliefs about the financial markets in which it invests portfolio assets.  The descriptions herein are in summary form, are incomplete and do not include all the information necessary to evaluate an investment in any investment or strategy.