Hidden Value Stocks issue for the first quarter ended March 31, 2020, featuring interviews with Nitin Sacheti of Papyrus Capital discussing Maui Land & Pineapple Company and Mike Melby of Gate City Capital discussing AMREP Corporation and Pico Holdings.
Welcome to the March 2020 (Q1) issue of Hidden Value Stocks.
This issue is packed full of stock ideas from some of our favorite funds, including Focused Compounding, Gate City Capital Management and Papyrus Capital.
In the first part of this issue, we have updates on ideas from Nitin Sacheti of Papyrus as well as Mike Melby of Gate City. Both of these managers believe that the stocks they highlighted in previous issues of Hidden Value Stocks remain undervalued, and have been adding to their holdings over the past two months. They explain why in the updates.
The primary interview in this issue is with Focused Compounding. Founded by Geoff Gannon and Andrew Kuhn, Focused Compounding started managing money as a hedge fund at the beginning of this year.
Geoff and Andrew also provide a managed account service, which they were able to start off the back of their subscription-based investing idea website, Focused Compounding back in 2018. Geoff and Andrew’s slogan is, “We spend 99% of our time focused on the 1% of stocks every other fund ignores.”
According to the team, they’re looking for “overlooked stocks” that have “durability.” They want to “find a business we’d be okay being stuck in permanently that’s in an industry we’d be okay being stuck in permanently.”
In the interview, Geoff highlights a handful of stocks currently owned by the managed accounts, as well as a few investments that have not worked out as expected.
At the end of this issue, there is also a table showcasing all of the stocks previously profiled in issues of Hidden Value Stocks.
We hope you enjoy this issue of Hidden Value Stocks, and if you have any questions or comments, please feel free to contact us at email@example.com.
Rupert Hargreaves & Jacob Wolinsky.
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Updates From Previous Issues: Papyrus Capital
In the Q3 2018 issue of Hidden Value Stocks, Nitin Sacheti of Papyrus Capital presented one of his favorite stock ideas at the time, Maui Land & Pineapple Company, Inc. (MLP).
Maui Land & Pineapple began life as a pineapple plantation over 100 years ago and subsequently built up a large landbank. However, the previous management team levered the business up significantly before the financial crisis. As a result, the partnership had to spend the next eight years rebuilding its balance sheet.
Now that the restructuring is complete, Maui Land & Pineapple is focusing on the development, and sale of its incredibly valuable land.
In his original thesis, Nitin explained that, based on recent land sales, the ultimate value of Maui Land & Pineapple Company’s land bank could be worth as much as $41 per share, offering a potential upside of 250% at the time.
Since this report was first published, Maui Land & Pineapple Company’s shares have struggled, but after recently agreeing on the sale of a substantial block of land for a price of around $1 million per acre, Nitin believes that this could be about to change.
What’s changed since your original report on the company, which was published in August 2017?
Since my report published in August 2018, the company has announced the sale of 46 acres in their Kapalua Central Resort project for $44 million, with an anticipated Q2/Q3 2020 closing date.
Has the deal altered your original investment case for the company at all?
We had anticipated that the company would either: (1) enter into a development JV for Central Resort or (2) sell the land.
The sale is at a lower price than our expected value of development, but timing is sooner, so it means more cash today. That is more valuable than cash flow over time (on which we put a multiple).
After the sale, the company now has 850 acres of comparable land left to sell. At a sale price of $1 million per acre, this land could be worth up to $850 million.
Do you think that’s a realistic breakdown of the company’s asset value?
I think the Central Resort land is slightly inferior to the rest of the 850 acres. The rest of the property is located in Kapalua, which is closer to the beach. As such, I’d say the rest of the 850 acres is at least worth $1 million an acre. This also does not put any value on MLP’s 10,800 acres of agricultural land and 9,000 acres of conservation land.
We put $20,000/acre on the agricultural land since they can sell/develop it over time (though it’s far inferior to the 900 acres in Kapalua). We put almost no value on the conservation land since this will stay protected. That adds just about another $200 million in value, on top of 850 acres plus cash. This all needs to be taxed at about 25%.
Is the company planning more land sales?
There are another 50 acres just north of Central Resort for which we believe the company has already received offers. We think they can sell this for another $50 million in the near term.
Management has also offloaded the Kapalua Water Company and Kapalua Waste Treatment Company. Can you explain why these deals were necessary for the business?
Selling the water utilities was necessary to improve the plant. The buyer, Hawaii Water Services, is much larger with a lower cost of capital. This will help fund improvements to the facility, which are needed to support so much additional development on Maui Land & Pineapple’s property.
They also have the knowhow to improve the facility. One thing we really like about Maui Land & Pineapple’s management is that they know what they are good at, and are not willing to undertake extensive development projects where they have little expertise.
We believe this speaks to how well they will allocate the $44 million coming in from the recent land sale along with future cash flow from additional land sales.
On that topic, what do you believe management is planning to do with the cash from these asset sales?
I believe management will distribute the cash to shareholders while holding some in reserve for buybacks, taxes, and nominal costs for the development of other projects.
The stock has gone nowhere over the past 12 months. What makes you think this is about to change?
The most considerable pushback on this stock has always been that they would never sell assets, and it would sit as a land bank for many years.
Clearly, the sale of the Central Resort land shows us that they are beginning to sell large pieces of the business to benefit shareholders. That means unlocking value in the stock. The stock has already started moving as investors start to appreciate this (aside from more recent COVID-19 related volatility).
What’s your view of Steve Case, the majority shareholder? Is he working to unlock value?
Steve Case’s father was the attorney for the original land trust. No one would know the assets better than the attorney for the trust. He told his son to buy it, so we know Mr. Case sees value in the asset and is clearly helping drive monetization.
You initially place a SOTP value of $41.39 per share. Has your evaluation of the business changed since the first interview?
I’d say my value of the business still holds at just above $40, but I do believe the substantial Kapalua Central Resort monetization will help the stock get there sooner rather than later!
Are there any developments that could invalidate your thesis and cause you to sell the position?
I think the risks are the same as the original writeup, somewhat mitigated by the asset sale (lower risk of Maui Land & Pineapple developing on their own). There are no new risks to the name that did not exist in 2018.
Interview One: Mike Melby - Gate City Capital
Hidden Value Stocks featured Gate City Capital in our Q1 2019 edition.
Gate City Capital’s founder, Mike Melby, picked out AMREP Corporation (AXR) and Pico Holdings Inc. (PICO) as his two favorite stocks at the time of the interview.
One year on, we asked Mike if he still likes these companies, if Gate City has been adding to its holdings, and what’s changed since our initial interview.
First of all, do you still hold a position in AMREP?
Thank you for reaching out. It is great to touch base again, and I am excited to provide an update on some companies we highlighted a year ago.
Gate City Capital Management still holds a position in AMREP, and we have added to our position over the last twelve months. I would refer you to the amended Form 13G filed on February 14, 2020, showing Gate City Capital Management as the beneficial owner of 15.91% of the outstanding shares.
A few months after we last spoke, AMREP announced the sale of its fulfillment business for $1 million in cash.
Do you think this was the right decision for the company, and how has it changed your estimate of intrinsic value for the business?
The sale of AMREP’s subscription fulfillment business was a significant event for AMREP. The transaction was structured, so the $1 million cash sale price was just a portion of the total consideration. In addition, the buyer continued to operate from AMREP’s two owned buildings in Palm Coast, Florida. The buyer agreed to lease these two buildings for a period of 10-years at an initial rate of $1.9 million/year, escalating to $2.5 million in year 10.
While we would have preferred more of the value recognized in the upfront purchase price, the lease rates are above market value and provide for additional consideration above the $1 million cash price.
In February 2020, AMREP also announced that it had agreed to sell one of the two owned buildings in Palm Coast, Florida, to the buyer of the subscription fulfillment business for $12.5 million.
Should the deal be completed, AMREP will receive an additional $12.5 million in proceeds in addition to the $1 million received in April 2019.
AMREP will also continue to own the second building in Palm Coast, which is currently leased through October 2020 at a rate of $550,000/year.
The transaction is consistent with our initial estimate of intrinsic value.
When we spoke in 2019, we assigned a value of $20 million for AMREP’s subscription fulfillment business, which included both the business operations and the two properties. Should the sale of the first building be completed, AMREP would have received $13.5 million in proceeds for the segment while continuing to own an additional building with a base rent of $550,000/year.
Despite this significant development, the stock has gone nowhere since our original interview. Why do you think this is?
As a brief overview, at AMREP’s current share price, the company has a market capitalization of approximately $46 million and an enterprise value of $34 million.
I do not have a good explanation for why AMREP’s stock continues to trade at levels well below what we consider to be intrinsic value. AMREP is a micro-cap company, with limited trading volume, which I expect limits the potential ownership base.
Moreover, AMREP is not covered by any sellside analysts and does not have a dedicated investor relations program, which likely limits the amount of information the investing public has on the company.
Our investment philosophy at Gate City Capital Management is to own companies trading at a significant discount to the value of their discounted free cash flows and provide a substantial margin of safety.
Since we last spoke, AMREP has performed well and has generated significant operating cash flow. Much of that cash flow generation is not apparent to investors as AMREP has contributed $5.6 million to the company’s pension plans during the last twelve months (this fulfilled a funding requirement following the sale of the subscription fulfillment business). AMREP’s pension liability stood at just $2.7 million as of October 31, 2019, and we do not expect the pension to require meaningful contributions from AMREP going forward.
We expect the company’s real estate operations to continue to generate free cash flow and expect a significant inflow of cash upon the completion of the sale of the company’s first building in Palm Coast, Florida. To that extent, we are happy to continue to own AMREP at current prices and will let other investors make their own decision on the value of those cash flows.
AMREP also owns a large amount of real estate, which the company is trying to monetize. What progress has it made on this front over the past 12 months?
AMREP’s real estate development business continues to perform well. As an overview, AMREP owns 18,000 acres of land in the city of Rio Rancho, New Mexico, and an additional 165 acres of land outside of Denver, Colorado. In Rio Rancho, AMREP develops the company’s land base into lots that are then
sold to homebuilders or other developers. As your readers might recall, there has been a shortage of developable land available for homebuilders across the nation, and AMREP’s broad base of land is a critical strategic asset.
Over the last twelve months, AMREP has sold approximately 33 acres of developed land in Rio Rancho for proceeds of over $13 million or about $400,000/acre. AMREP continues to develop four subdivisions in Rio Rancho actively, and we expect robust sales in the area to continue.
In addition, AMREP is currently constructing a building on one of the company’s commercial lots in Rio Rancho that will be a retail store for Natural Grocers, the health food grocery chain.
The construction costs are approximately $2.8 million, and we expect the value of the building to be worth considerably more than that when construction is completed this summer. This building can either be held for recurring revenue or monetized.
AMREP is also advancing on plans to monetize the company’s land base in Colorado. AMREP owns a 160-acre
subdivision called Mountain View Estates in the Denver suburb of Brighton, Colorado.
Mountain View Estates is surrounded by completed developments but has thus far been restricted from moving forward with development due to water issues encountered by a neighboring subdivision. We believe these issues are being remedied, and AMREP should be able to proceed with either the development or outright sale of Mountain View Estates within the next 12-18 months. AMREP also owns a 4.6-acre commercial tract in the Denver suburb of Parker, Colorado. The land is prime real estate on the corner of Main Street and Jordan Road and is being marketed for sale at $4.4 million. Finally,
AMREP also owns mineral rights under the 160 acres of Mountain View Estates. Great Western Energy is drilling in the immediate vicinity, and we are hopeful AMREP will realize some value from the company’s mineral rights in the next few quarters.
In summary, has your estimate of intrinsic value for the business changed at all considering the progress the business has made over the past year?
My estimate of intrinsic value is relatively unchanged. I have a target market capitalization of $92.5 million, equating to $11.40/share and representing over 100% upside to the current share price.
Pico Holdings Inc
The other stock you highlighted in our Q1 2020 was Pico Holdings Inc. Have you made any changes to your position?
Gate City Capital Management has added to our position in Pico over the past 12 months. In our initial interview, you claimed that the company’s water rights and credits are worth more than the value implied by the market cap of the business.
Pico has completed a handful of asset sales over the past year. Have these deals confirmed your original claim?
As a reminder to your readers, Pico owns water rights, water credits, and related infrastructure in the southwestern United States. Pico’s water assets are located in rapidly-growing areas, including Reno, Nevada, Phoenix, Arizona, and Las Vegas, Nevada.
Pico has a market capitalization of approximately $200 million and an enterprise value of $190 million. In the last twelve months ending September 2019, Pico generated almost $22 million in water and land sales. These sales include 175 acre-feet of water credits in Reno, Nevada for proceeds of over $6 million or $35,000/acre-feet, the sale of 470 acre-feet of water rights in northern Nevada for $3 million in proceeds, and $8.9 million in land sales. Additionally, in Q4 2019, Pico sold 25,000 acre-feet of water credits for $8.7 million in proceeds. These sales were all consistent with our expectations.
Pico continues to own 7,800 acre-feet of water credits that are designed to serve the North Valleys communities of Reno, Nevada, and are currently being marketed for $36,000/acre foot. There are several large subdivisions in the North Valleys that we expect to have demand for these water credits. Pico also continues to own over 28,000 acre-feet of water credits in the Phoenix area that we value at $350/credit and 250,000 acre-feet of water credits 70 miles west of Phoenix that we value at $250/ credit. Additionally, Pico owns water rights in other vital areas, including Carson City, Nevada, and north of Las Vegas that have significant value.
In our initial interview, you also stated that based on your analysis of land values, the intrinsic value of the business was $22.50 per share. Has your view changed at all based on recent deals?
Our view of intrinsic value has not changed – we believe it is supported by the recent transactions.
The firm recently announced a $100 million share buyback. Do you think this was the right action for management to take?
The announcement is further evidence of the company’s intention to monetize assets and return proceeds to shareholders. Pico has completed over $38 million in share buybacks in the last three years in addition to paying a $5.00 special cash dividend of almost $116 million.
The $100 million share buyback indicates that management and the board expect to monetize a significant amount of assets over the next few years and have the intention of returning the proceeds to shareholders.
Our view is that the company’s assets are worth significantly more than the price implied by the company’s share price, and utilizing asset sale proceeds to repurchase stock is a good use of capital.
You initially projected that it could take 10 years for the company to wind-down. Is this time frame still realistic?
That time frame remains consistent.
And finally, last year, you pegged your worst-case scenario downside target at $9.50 per share. Does this still stand?
Our downside scenario is consistent with last year’s levels and is currently at $9.00/share. I would highlight that this does not represent a “worst-case scenario,” which could involve any number of geopolitical events beyond our control. Our downside is based on an orderly liquidation of the company’s assets at sizeable haircuts to current market prices.
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Market Rout Extends With Futures Tumbling To Verge Of Bear Market
Market Rout Extends With Futures Tumbling To Verge Of Bear Market
US stock futures slumped again, extending yesterday’s brutal selloff that…
US stock futures slumped again, extending yesterday’s brutal selloff that erased $1.5 trillion in market value on concerns about everything from slowing growth, to Chinese lockdowns, to soaring inflation and tightening monetary policy. Contracts on the S&P 500 were down 1.2% 7:30 a.m. in New York, having earlier dropped to 3,856, one point away sliding 20% from January's all time highs, and triggering a bear market. The underlying index tumbled 4% on Wednesday, the most since June 2020, as consumer shares cratered after Target slashed its profit forecast due to a surge in costs. Nasdaq 100 futures were down 1.2%. 10Y TSY Yields slumped about 7bps, dropping to 2.833, while the dollar also dropped after yesterday's surge; bitcoin was flat around $29K.
The retail rout continued on Thursday: shares of US retailers again tumbled in premarket trading amid growing worries over the impact of rising inflation and the ability of companies to pass on higher costs to consumers; with Bath & Body Works becoming the latest retailer to cut its guidance. Major technology and internet stocks were also down, pointing to further losses in major technology and internet stocks a day after the tech-heavy Nasdaq slumped to its lowest since November 2020. Apple (AAPL US) -1.2%, Microsoft (MSFT US) -1.2%, Meta Platforms (FB US) -1.1%, Netflix (NFLX US) -0.9% and Nvidia (NVDA US) -2.2% in premarket trading. US rail stocks may be in focus as Citi cuts ratings on Norfolk Southern (NSC US), Union Pacific (UNP US) and US Xpress Enterprises (USX US) to neutral from buy, while lowering 2023 estimates “across the board.”Here are some other notable movers:
- Cisco Systems (CSCO US) plunged 13% in premarket trading after the network-gear maker spooked investors with a warning that Chinese lockdowns and other supply disruptions would wipe out sales growth in the current quarter. Shares of networking equipment makers drop after Cisco cuts outlook, with Broadcom (AVGO US) -3.6% and Juniper Networks (JNPR US) -5.9% in premarket trading.
- Synopsys (SNPS US) rises 3.8% in premarket trading after the supplier of software used to design semiconductors boosted its profit and revenue guidance for the full year.
- Target (TGT US) shares fall 2.2% in premarket trading, Walmart (WMT US) -0.3%; Kohl’s (KSS US) is in focus after two senior executives depart
- Under Armour (UAA US) shares dropped as much as 6% in US premarket trading, with analysts saying that the departure of the sportswear maker’s CEO Patrik Frisk is a surprise and adds uncertainty.
- Bath & Body Works’s (BBWI US) outlook cut was a little greater than expected, though analysts noted that it was due to higher costs and investment. The company’s shares fell almost 4% in premarket trading.
- United Wholesale Mortgage (UWMC US) will struggle to main its 1Q earnings level in coming quarters, Piper Sandler says in a note downgrading the stock to underweight from neutral. Shares drop as much as 7% in US premarket trading.
The S&P 500 is on track for its longest weekly losing streak since 2001 as traders flee risk assets over fears that the Federal Reserve will push the economy into a recession as it tries to curb inflation. The benchmark is close to falling into a bear market, after dropping 18% from a record high in January.
"The US selloff was rather orderly and the market isn’t oversold, yet. That tells us that we are likely not at the bottom yet,” said Joachim Klement, head of strategy, accounting and sustainability at Liberum Capital. “Consumer sentiment remains depressed and we are seeing consumers retrenching on some discretionary spending.”
Speaking on Tuesday in his most hawkish remarks to date, Fed Chair Jerome Powell said the US central bank will keep raising interest rates until there is “clear and convincing” evidence that inflation is in retreat. JPMorgan's Marko Kolanovic, meanwhile, said - what else - that things can get better for US stocks. “There will be no recession this year, some summer increase in consumer activity on the back of reopening, China increasing monetary and fiscal measures,” he said. Bolstering his opinion is a conviction that US inflation has probably peaked, or is about to do so, paving the way for a pullback in price pressures that will eventually allow the Federal Reserve to moderate the pace of monetary tightening.
"Since we are pricing in a growth scare but not yet a recession, we could see further downside in the coming weeks, but we are starting to price in a very negative picture already, suggesting we should, at some point, be closer to the bottom,” said Esty Dwek, chief investment officer at Flowbank SA. US stock investors are pricing in stronger odds of a recession than are evident from positive macroeconomic indicators, according to Goldman Sachs strategists.
"A recession is not inevitable,” Goldman strategists led by David J. Kostin wrote in a note. “Rotations within the US equity market indicate that investors are pricing elevated odds of a downturn compared with the strength of recent economic data.”
Bets that robust earnings can help investors weather this year’s turbulence were thrown in doubt after US consumer titans signaled growing impact of high inflation on margins and consumer spending. Meanwhile, Federal Reserve officials reaffirmed that tighter monetary policy lies ahead, and investors fretted over stagflation risks.
“We are pricing in a growth scare,” Lori Calvasina, the head of US equity strategy at RBC Capital Markets, told Bloomberg TV. “There is a lot of uncertainty in this market right now about whether or not that recession is going to come through or if it’s going to be another near-death experience.”
There was some more good news on the China covid lockdown front: Shanghai Vice Mayor said Shanghai port throughput recovered to around 90% of the levels a year ago and that Shanghai will expand work resumption in areas with no COVID risk in early June. Furthermore, Shanghai is to gradually restore inter-district public transport from May 22nd and will require residents to show negative PCR tests taken within 48 hours before using public transport, while an economy official said Shanghai will reduce rents for small and medium-sized enterprises by more than CNY 10bln and the city extended CNY 72.3bln of loans to over 10,000 firms since March, according to Reuters.
In Europe, the Stoxx 600 retreated 1.8%, after sliding more than 2% earlier, with all industry sectors in the red and personal care and financial services leading the decline as Wednesday’s retailer trouble in the U.S. spills over into Europe. FTSE 100 lags regional peers, dropping 2%. Here are some of the biggest European movers today:
- HomeServe shares jump as much as 12% after Brookfield agrees to buy the home emergency and repair services company for GBP4.1b.
- Societe Generale shares rise as much as 1.5%, as it was raised to outperform from market perform at KBW, with the broker saying the sale of Russian activities removes a key overhang for the bank and should result in a re-rating.
- Generali shares rose as much as 1.4% after 1Q profit beats analyst estimates as EU136m impairments on Russian investments were more than offset by higher operating income.
- PGNiG shares rise as much as 6.2% after reporting 1Q results that, according to analysts, support Polish gas company’s outlook.
- Nestle shares drop as much as 5.3% after Bernstein downgraded the stock to market perform from outperform, saying the shares will “struggle” if market sentiment improves and investors exit havens.
- Royal Mail shares fall as much as 14% after the postal group’s FY results slightly missed estimates and analysts said its outlook is “disappointing.”
- National Grid shares fall as much as 2.5%, erasing gains from yesterday’s record high, after the utility company reported full-year results.
Earlier in the session, shares of Asian retailers follow their US counterparts lower after Target became the second big retailer in two days to trim its profit forecast.
- Australia: JB Hi-Fi retreats 6.6%, Wesfarmers -7.8%, Harvey Norman -5.5%, Woolworths -5.6%
- South Korea: E-Mart - 3.4%; apparel makers Hansae -9.4%, F&F -4.2%, Youngone -8.2%
- Japan: Fast Retailing - 3.1%, MatsukiyoCocokara -1.4%, Ryohin Keikaku -1.7%, Nitori -3%
- Singapore: Grocery chain operator Sheng Siong slips as much as 1.3%
- Hong Kong: Sun Art Retail down as much as 4.1%
In China, Tencent Holdings Ltd. plunged 6.6% after warning it will take time for Beijing to act on promises to prop up the Chinese tech sector. Cisco Systems Inc. slid in extended US trading on a disappointing revenue outlook.
Japan's Nikkei 225 suffered firm losses amid reports the ruling coalition is considering increasing the corporate tax rate and after several data releases in which Machinery Orders topped estimates but Exports missed as China-bound exports declined by the fastest pace since March 2020.
Indian stocks declined to a ten-month low, tracking a sell-off across Asia, on concerns the US Fed’s hawkish stance on inflation may cool economic activity and hurt consumer demand. The S&P BSE Sensex plunged 2.6% to 52,792.23, its lowest level since July 30, in Mumbai, while the NSE Nifty 50 Index slipped 2.7% to 15,809.40 Software exporter Infosys Ltd. fell 5.4% to a 11-month low and was the biggest drag on the Sensex, which had 27 of 30 member stocks trading lower. All 19 sector indexes compiled by BSE Ltd. declined, led by S&P BSE Information Technology index, that dropped the most in over two years. “Deteriorating macro sentiment such as soaring inflation, recession fears, and the prospect of the Federal Reserve getting even more hawkish will continue to keep benchmarks on the edge,” Prashanth Tapse, an analyst at Mehta Equities Ltd., wrote in a note. In earnings, of the 36 Nifty 50 firms that have announced results so far, 21 have either met or exceeded analyst estimates, while 15 have missed forecasts.
In Australia, the S&P/ASX 200 index fell 1.7% to close at 7,064.50, tumbling with global shares as concerns over inflation, interest-rate hikes and Ukraine piled up. All sectors dropped, except for health. Consumer shares were among the worst performers, following their US peers lower after Target became the second big retailer in two days to trim its profit forecast. Aristocrat rose after it released its 1H results and unveiled buyback plans. In New Zealand, the S&P/NZX 50 index fell 0.5% to 11,206.93
And in emerging markets, Sri Lanka fell into default for the first time in its history as the government struggles to halt an economic meltdown that prompted mass protests and a political crisis. An index of developing-nation stocks slumped more than 2%.
In FX, the Bloomberg dollar spot index declines, with all G-10 majors rising against the greenback. CHF is the strongest G-10 performer with USD/CHF snapping lower on to a 0.97 handle and EUR/CHF slumping below 1.03. The Swiss franc diverged from Japanese yen and dollar after hawkish comments from SNB’s Thomas Jordan Wednesday, which assured traders CHF rates could follow EUR higher. Options trades may also be behind the latest move in the spot market.
In rates, Treasury yields dropped about seven basis points as investors sought insurance against further declines in risk assets. Treasury yields richer by up to 6bp across belly of the curve, richening the 2s5s30s fly by 2.2bp on the day; 10-year yields around 2.83% with German 10-year outperforming by 2.5bps. Treasuries extended Wednesday’s rally as stocks resume slide with S&P 500 futures dropping under 3,900 to lowest level in a year; on the curve, the belly led the advance while bunds outperform in a more aggressive bull-flattening move as European stocks tumble. US session highlights include 10-year TIPS reopening at 1pm ET. Flurry of block trades during London session follows a spate of trades Wednesday; five blocks worth a combined cash-equivalent $1.2m/DV01 between 3:38am and 5:35am similarly entailed price action consistent with sales. Most European bonds also gained, with the yield on German 10-year securities falling more than basis points. German yield curve bull-flattens: 30-year yield drops ~9bps before stalling near 1.05% which has acted as support for much of May so far.
The Dollar issuance slate empty so far; eight borrowers priced $8.5b Wednesday, and new issue activity is expected to be muted during remainder of the week. Three-month dollar Libor +2.69bp to 1.50486%. Economic data slate includes May Philadelphia Fed business outlook and initial jobless claims (8:30am), April existing homes sales and leading index (10am).
In commodities, crude oil extended declines, while most industrial metals were in the red as global growth fears damped the demand outlook. WTI reverses Asia’s gains, dropping back below $110 but holding above Wednesday’s lows. Spot gold is comparatively quiet, holding above $1,810/oz. Most base metals trade in the green; LME tin rises 2.1%, outperforming peers while copper held near a seven-month low and zinc extended losses.
Bitcoin is modestly softer in a relatively contained range that lies just shy of the USD 30k mark. Crypto exchange FTX to start rollout of new stock-trading service on Thursday, WSJ reports; will not accept payment for order flow on stock trades.
Looking to the day ahead now, and data releases from the US include the weekly initial jobless claims, along with April’s existing home sales and the Philadelphia Fed’s business outlook survey for May. Central bank speakers include ECB Vice President de Guindos, the ECB’s Holzmann and the Fed’s Kashkari. Finally, the ECB will be publishing the minutes from their April meeting.
- S&P 500 futures down 1.1% to 3,879.25
- STOXX Europe 600 down 1.7% to 426.41
- MXAP down 1.8% to 161.60
- MXAPJ down 2.2% to 527.30
- Nikkei down 1.9% to 26,402.84
- Topix down 1.3% to 1,860.08
- Hang Seng Index down 2.5% to 20,120.68
- Shanghai Composite up 0.4% to 3,096.97
- Sensex down 2.4% to 52,926.71
- Australia S&P/ASX 200 down 1.6% to 7,064.46
- Kospi down 1.3% to 2,592.34
- Gold spot down 0.1% to $1,814.49
- U.S. Dollar Index down 0.28% to 103.52
- German 10Y yield little changed at 0.96%
- Euro up 0.3% to $1.0496
- Brent Futures down 0.1% to $109.00/bbl
Top Overnight News from Bloomberg
- President Joe Biden is set to meet on Thursday with Finland’s President Sauli Niinisto and Swedish Prime Minister Magdalena Andersson at the White House to discuss the Nordic nations’ NATO bids.
- China’s top diplomat again warned the US over its increased support for Taiwan, showing the island democracy remains a major sticking point between the world’s biggest economies as Beijing sent more military aircraft toward the island
- Sri Lanka fell into default for the first time in its history as the government struggles to halt an economic meltdown that prompted mass protests and a political crisis
- The yuan’s outlook is finally looking more balanced after a 6.5% dive versus its major trading partner currencies since March.
A more detailed look at global markets courtesy of Newsquawk
Asia-Pac stocks were pressured on spillover selling after the worst day on Wall St in almost two years. ASX 200 was led lower by consumer staples following the retailer woes stateside and mixed Australian jobs data. Nikkei 225 suffered firm losses amid reports the ruling coalition is considering increasing the corporate tax rate and after several data releases in which Machinery Orders topped estimates but Exports missed as China-bound exports declined by the fastest pace since March 2020. Hang Seng and Shanghai Comp initially weakened with the Hong Kong benchmark dragged lower by heavy losses in tech after Tencent’s profit declined by more than 50% and with the mainland pressured as Beijing conducts a fresh round of mass COVID testing, although the mainland bourse recovered most of its losses after Shanghai announced a further gradual easing of restrictions. Xiaomi (1810 HK) Q1 adj. net profit CNY 2.859bln (vs 6.069bln Y/Y), Q1 revenue CNY 73.4bln (vs. 76.9bln Y/Y); global smartphone shipments -10.5% Y/Y at 38.5mln units.
Top Asian News
- Shanghai Vice Mayor said Shanghai port throughput recovered to around 90% of the levels a year ago and that Shanghai will expand work resumption in areas with no COVID risk in early June. Furthermore, Shanghai is to gradually restore inter-district public transport from May 22nd and will require residents to show negative PCR tests taken within 48 hours before using public transport, while an economy official said Shanghai will reduce rents for small and medium-sized enterprises by more than CNY 10bln and the city extended CNY 72.3bln of loans to over 10,000 firms since March, according to Reuters.
- Japanese MOF official said China's COVID curbs are among the factors that caused a decline in China-bound exports from Japan which fell by the fastest pace since March 2020, while Japan's April imports reached the largest amount on record, according to Reuters.
- Japan's ruling coalition is reportedly considering increasing the corporate tax rate, according to Jiji.
- New Zealand sees 2021/22 OBEGAL at NZD -18.98bln (prev. forecast -20.44bln), 2021/22 net debt at 36.9% of GDP (prev. forecast 37.6%) and Cash Balance at NZD -31.78bln (prev. forecast -34.10bln), while Finance Minister Robertson said the economy is expected to be robust in the near term and they see a return to OBEGAL surplus in 2024/25, according to Reuters.
European bourses are pressured across the board in a broader risk-off moves after yesterday's Wall St. sell off, as European players look past the brief respite seen overnight on Shanghai's reopening; Euro Stoxx 50 -2.3%. Stateside, the magnitude of the downside is somewhat more contained given newsflow has been limited since Wednesday's downside commenced, ES -1.2%.
Top European News
- EU is reportedly considering a targeted trade war on troublesome Brexiteer MPs and Tory ministers to force UK PM Johnson to do a U-turn on the Northern Ireland protocol, according to The Telegraph.
- Top UK Economist Defends BOE’s Handling of Inflation Crisis
- EasyJet Bookings Pick Up Ahead of Uncertain Summer Season
- Apax-Owned Rodenstock Acquires Spanish Rival Indo
- European Gas Slips With LNG Imports Helping Boost Stockpiles
- Franc resurgence and re-emergence as a safe haven currency continues; USD/CHF touches 0.9750 vs 1.0060+ peak on Monday, EUR/CHF sub-1.0250 vs circa 1.0500 at one stage only yesterday.
- Dollar loses momentum as US Treasury yields retreat further and curve re-flattens amidst ongoing risk rout, DXY ducks under 103.500 after peaking just shy of 104.000 on Wednesday.
- Kiwi and Aussie find positives via fiscal and fundamental factors to evade aversion; NZD/USD back above 0.6300 after NZ budget and AUD/USD hovering around 0.7000 post- Aussie jobs data.
- Yen retains underlying bid irrespective of mixed Japanese data, USD/JPY below 128.00 again.
- Euro firmer beyond EUR/CHF cross ahead of ECB minutes and Sterling off UK inflation data lows awaiting retail sales on Friday, EUR/USD retains sight of 1.0500 and Cable near 1.2400.
- Rand meandering ahead of SARB in anticipation of 50 bp rate hike, USD/ZAR around 16.0000, irrespective of Gold taking firmer hold of USD 1800/oz handle.
- Debt resumes safe-haven rally as market mood continues to sour.
- Bunds top 154.00, Gilts get close to 120.00 and 10 year T-note even nearer the same psychological level.
- BTPs lag amidst the ongoing aversion to risk, while OATs and Bonos reflect on somewhat mixed auction results.
- WTI and Brent are pressured in-fitting with broader sentiment as initial resilience on demand-side positives re. China/COVID were overpowered by the risk move.
- However, the benchmarks are around USD 1.00/bbl off lows of USD 104.36/bbl and USD 106.76/bbl respectively, following reports that China is discussing the purchase of Russian crude.
- China is said to be in talks with Russia to purchase oil for strategic reserves, according to Bloomberg sources; detailed on terms and volume reportedly not decided yet
- Qatar Energy was reportedly selling July Al-Shaheen crude at premiums of USD 5.80-6.40/bbl above Dubai quotes which is the highest in 2 months, according to Reuters sources.
- Spot gold is bid as it draws haven allure, with the yellow metal marginally surpassing USD 1830/oz.
US Event Calendar
- 08:30: May Initial Jobless Claims, est. 200,000, prior 203,000; Continuing Claims, est. 1.32m, prior 1.34m
- 08:30: May Philadelphia Fed Business Outl, est. 15.0, prior 17.6
- 10:00: April Existing Home Sales MoM, est. -2.2%, prior -2.7%; Home Resales with Condos, est. 5.64m, prior 5.77m
- 10:00: April Leading Index, est. 0%, prior 0.3%
DB's Jim Reid concludes the overnight wrap
Today is my last day at work this week before I head up to Cambridge tomorrow for my Masters’ graduation. Before you send in a flood of congratulations though, I didn’t actually do any work for this qualification, with not even a single hour of revision. Now at this point you’re probably thinking I’m either a genius or guilty of some serious academic malpractice. I’m hoping the former. But the truth is that I’m benefiting from a quirky tradition that somehow means Cambridge, Oxford and Dublin will upgrade your Bachelors into a Masters after a few years. With the wedding two months away, it appears as though I’m losing all my bachelor status at once.
Markets seem ready for a holiday too after the last 24 hours, with the selloff resuming at pace after the brief respite on Tuesday. In fact it was nothing short of a rout with the S&P 500 ending the day down -4.04%, marking its worst daily performance since June 2020, and leaving the index at a fresh one-year low. There wasn’t a single catalyst behind the slump, but weak housing data out of the US along with Target’s move to cut its profit outlook helped feed investor concern that the consumer might not be in as strong a position as previously thought. And that’s on top of all the other worries of late that the global economy is heading in a stagflationary direction amidst various supply-chain issues, alongside the prospect that tighter central bank policy is going to further dent growth and risks tipping various economies into recession.
In terms of the specific moves, the S&P 500 gradually tumbled as the day went on, with its -4.04% decline more than reversing its +2.02% bounceback on Tuesday. The decline was an incredibly broad-based one, with just 8 constituents in the index ending the day higher, which is the lowest number since November. That earnings report we mentioned at the top meant that Target (-24.93%) saw the worst performance in the entire S&P 500, after saying they now expected their full-year operating income margin rate to be around 6%. That follows a disappointing report from Walmart the previous day, and meant that consumer staples (-6.38%) and consumer discretionary (-6.60%) were the worst-performing sectors in the S&P yesterday. The latest declines also mean that the S&P is back on track for a 7th consecutive weekly decline, having shed -2.49% since the start of the week, and S&P 500 futures are only up by +0.18% this morning. If the S&P 500 does see a 7th week in negative territory, then that would be the longest run of weekly declines for the index since 2001. Other indices lost ground too given the risk-off move, with the Dow Jones (-3.57%), the NASDAQ (-4.73%), and the small-cap Russell 2000 (-3.56%) all experiencing sizeable declines of their own. European indices had a better performance after closing before the worst of the US declines, and the STOXX 600 was “only” down -1.14% to just remain in positive territory for the week.
With recessionary concerns back in focus, sovereign bonds rallied on both sides of the Atlantic as investors sought out safe havens. Yields on 10yr US Treasuries fell by -10.2bps to 2.88%, with the decline mostly led by a -9.6bps move lower in real yields, and nominal yields are only back up +2.5bps this morning. The yield curve also continued to flatten and the 2s10s slope (-6.9ps) fell to its lowest in over two weeks, at 21.0bps, although it’s been over 6 weeks now since the curve last traded in inversion territory. We did get some Fedspeak but to be honest there weren’t any major headlines relative to what we already knew, with Chicago Fed President Evans saying it was “quite likely” the Fed would be at a neutral setting by year-end, whilst Philadelphia Fed President Harker was making the case for more gradual rate hikes after the next few 50bp hikes are delivered. More important for the outlook was the release of various housing data yesterday, where housing starts fell to an annualised rate of 1.724m in April (vs. 1.756m expected), and that was from a downwardly revised 1.728m in March. That comes against the backdrop of rising mortgage rates, and the MBA reported that mortgage purchase applications fell -11.9% in the week ending May 13, leaving them at their lowest levels since May 2020 when the numbers were still recovering from the pandemic slump.
Over in Europe, sovereign bond curves also became flatter as investors became increasingly aggressive on the near-term ECB rate path. Indeed the amount of ECB rate hikes priced in by the December meeting hit a fresh high of 108bps, or equivalent to at least four rate hikes of 25bps by year-end. That came amidst further ECB speakers over the last 24 hours, including Finnish central bank governor Rehn, who had already endorsed a July hike and said yesterday that the initial hike was “likely to take place in the summer”. Furthermore, he said that it seemed “necessary that in our policy rates we move relatively quickly out of negative territory”. We also heard from Estonian central bank governor Muller, who also endorsed a July hike and said he “wouldn’t be surprised” if the deposit rate were in positive territory by year-end. However, Spanish central bank governor De Cos said that rate hikes should be gradual as he called for APP purchases to end at the start of Q3, with rate hikes to follow shortly afterwards.
Those growing expectations of tighter policy saw shorter-dated yields move higher in Europe once again, with 2yr German yields hitting their highest level since 2011 despite only a marginal +0.1bps move to 0.36%. However, the broader risk-off tone meant it was a different story for their longer-dated counterparts, and yields on 10yr bunds (-1.6bps) and OATs (-2.2bps) both moved lower on the day. Peripheral spreads widened as well, whilst iTraxx Crossover neared its recent highs with a +26.2bps move to 468bps.
In terms of the fight against inflation, there was a potential boost on the trade side yesterday as US Treasury Secretary Yellen confirmed ahead of a meeting of G7 finance ministers and central bank governments that the she favoured removing some tariffs on goods that are not considered strategic. Separately the risk-off move also saw oil prices move lower for a 2nd day running yesterday, with Brent crude down -2.52%, although it’s since taken back a decent chunk of that loss this morning with a +1.51% move higher to $110.76/bbl.
Over in Asia, equity markets have tracked those steep overnight losses on Wall Street to move sharply lower this morning. Among the key indices, the Hang Seng (-2.25%) is the largest underperformer amidst a broad weakness in tech stocks as the Hang Seng Tech index fell by an even larger -3.40%. Mainland Chinese stocks have performed relatively better however, even if the Shanghai Composite (-0.08%) and CSI (-0.25%) have both moved slightly lower, while the Nikkei (-1.91%) and the Kospi (-1.29%) have seen more substantial losses. Finally there was some important employment data out of Australia this morning ahead of their election on Saturday, with the unemployment rate falling to its lowest since 1974, at 3.9%. The employment gain was a bit softer than expected with just a +4.0k gain (vs. +30.0k expected), but that included a +92.4k gain in full-time employment, offset by a -88.4k decline in part-time employment.
Elsewhere on the data side, there were fresh signs of inflationary pressure in the UK after CPI inflation rose to a 40-year high of +9.0% in April. But in spite of the 40-year high, that was actually slightly beneath the +9.1% reading expected by the consensus, which marked the first time in over 6 months that the reading hasn’t been higher than expected. Gilts outperformed following the release as it was also beneath the BoE’s staff projection of +9.1%, and 10yr gilt yields closed down -1.6bps on the day, whilst sterling underperformed the other major currencies leave it -1.28% weaker against the US Dollar.
To the day ahead now, and data releases from the US include the weekly initial jobless claims, along with April’s existing home sales and the Philadelphia Fed’s business outlook survey for May. Central bank speakers include ECB Vice President de Guindos, the ECB’s Holzmann and the Fed’s Kashkari. Finally, the ECB will be publishing the minutes from their April meeting.
Monitoring Investment Regime Trends With ETF Pairs
Markets move in waves and it’s valuable to keep an eye on the big-picture ebbs and flows for context with portfolio rebalancing, adjusting risk exposure…
Markets move in waves and it’s valuable to keep an eye on the big-picture ebbs and flows for context with portfolio rebalancing, adjusting risk exposure and much more. There are several ways to track these broad moves. One of the more useful methodologies is watching the ratio of prices for a given investment theme.
Using various pairs of ETFs is a useful approach and on that basis this column marks the start of an ongoing periodic review of what I’m calling investment regime trends. There’s a long list of worthy ETF pairs to monitor, but as a start let’s limit the view to five in this debut. In future columns I’ll expand the vista, highlighting trends that are timely for one reason or another.
Here’s one way to quantify what might be called a measure of risk-on/risk-off at a high level for portfolio strategy via a pair of asset allocation ETFs. One is an aggressive portfolio mix (AOA), the other a conservatively run allocation (AOK). For this ratio, a rising trend implies a productive regime for risk-on strategies. By that measure, the strong rebound off the pandemic low has stalled in recent months and this trend appears to be at risk of rolling over and reversing.
US Stocks-US Bonds
Next up is the US stocks (SPY)/bonds (BND) regime. Here, too, the trend has stalled recently, although it hasn’t rolled over yet, largely because the loss for bonds has been greater than stocks in recent history, although this is starting to change. As a result, this indicator appears set for a downside reversal after an extended bull run.
The recent surge in inflation remains on the short list of risk factors that are driving market behavior this year and the price ratio for an inflation-indexed Treasuries ETF (TIP) and a nominal Treasuries ETF (IEF) suggests the inflation/reflation momentum remains strongly bullish.
Tracking the risk-on/risk-off trend for US Treasuries via a set of medium-term (IEF) and short-term (SHY) ETFs reminds that staying defensive in this corner still looks timely.
US Cyclical Equities
Staying defensive also has merit by favoring shares of consumer staples (XLP) over so-called discretionary names (XLY).
How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report
recession pandemic bonds us treasuries stocks etf recession
JPY forecast amid the Bank of Japan keeping the monetary policy easy
The rapid depreciation of the Japanese yen (JPY) in the last couple of years led to one of the most impressive moves seen in the FX market in recent history….
The rapid depreciation of the Japanese yen (JPY) in the last couple of years led to one of the most impressive moves seen in the FX market in recent history. The yen simply melted, losing value against all its peers – not only against the US dollar.
Speaking of the US dollar, the yen dropped to over 131 recently before gaining some ground in the last few days. How will the yen perform for the rest of the year, and is the Bank of Japan right in keeping the monetary policy easy?
Bank of Japan still sees inflation as transitory
The main reason for the JPY’s move lower is the Bank of Japan’s policy. The central bank sees inflation as transitory, and, for this reason, it keeps the monetary policy easy.
It keeps buying government bonds, despite PPI or Producers Price Index (i.e., inflation on the producers’ side) rising at a four-decade high.
But so did the Fed, before dropping the transitory word when talking about inflation. If the PPI transfers to consumers, as it should, then the Bank of Japan would have to reverse its policy.
Truth be said, inflation in Japan is below 2% for decades, hurting the Bank of Japan’s credibility. It might have dramatic implications on the FX dashboard if it rises considerably above the target.
Only that the FX market is a leading one. Traders speculate and position themselves well before a central bank acts.
So did we see the lowest point in the JPY or not?
AUD/JPY daily chart points to a possible reversal
All JPY pairs’ charts look more or less like the AUD/JPY daily chart below. It shows that following the COVID-19 pandemic dip in 2020, the market rallied relentlessly.
But the recent breakout in 2022 following the Bank of Japan’s yield curve control comments is only the last leg of an otherwise super long trend. In other words, the yen was sold well ahead of the Bank of Japan’s comments. It followed the US stock market higher.
Now that the US stock market is coming down (i.e., Nasdaq 100 dropped -28% YTD), the JPY pairs may follow. The AUD/JPY chart above shows a possible head and shoulders pattern at the top which might just signal the top of a bigger head and shoulders pattern.
In other words, should the recent highs hold, a move back to 80 should not be discounted, especially if the US stock markets keep falling.
The post JPY forecast amid the Bank of Japan keeping the monetary policy easy appeared first on Invezz.bonds yield curve government bonds pandemic covid-19 nasdaq monetary policy fed us dollar stock markets japan
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