Media Worth Consuming – October 2019

Jonathan Rochford

Narrow Road Capital

S&P 500 companies are paying out over 100% of their free cashflow as dividends and buybacks, even though earnings growth has been flat for the last two quarters and is likely to be negative for the quarter just ended. On some measures, the US stock market isn’t bubbly at all. Insiders are selling their stock at the highest pace in 20 years. US rail freight levels are down 5% year on year and container shipping rates are down 43% year on year. Inflation, exports and imports are all negative in South Korea. If you subscribe to the skyscraper theory, risk assets are due for a downturn. VIX is indicating everything is ok, but skew is signalling problems ahead.

29% of US leveraged loans are rated B- and another 11% are rated CCC or below, which creates price jump risk for CLOs facing rating constraints. Some CLOs are giving themselves up to 50% CCC allowances so they can buy distressed debt when others are forced to sell. Underwriting banks are getting stuck with leveraged loans again. Standard and Poor’s sees a growing pile of “weakest link” corporates that will form a default wave in the next downturn. LBO companies rarely hit their EBITDA growth and debt reduction targets put forward at the time of borrowing. EBITDA adjustments in private equity transactions are at a record high, with adjustments nearly half of EBITDA for B rated companies.

Some “investment grade” bond funds are loading up on debt with split BBB/BB ratings to boost returns. AMP raised a $6.2 billion infrastructure debt fund, adding to a crowded sector. Moody’s sub-investment grade downgrade to upgrade ratio has substantially deteriorated this year. Rating agencies are giving some big corporates several years of leeway to earn the rating they currently have. Defaults are jumping in the municipal bond market. Stretched consumers and pricier cars are pushing American auto loans out to nearly six years on average. An American farm lender threw underwriting standards out the window and now has 13% of its loan book as non-performing. The US Treasury Department is regularly approving reductions in pension benefits for defined benefit funds heading towards insolvency.

The Bank for International Settlements studied the impact of low interest rates and found that banks reduced lending and increased risk taking as a result. Smaller German banks are increasingly passing on negative interest rates to their retail clients with larger banks considering doing the same. Greece is selling short term debt at negative interest rates. Falling yields on Greek and Italian government debt points to desperate investors rather than an economic turnaround. Greece’s government is set take a huge risk guaranteeing the senior tranche in a securitisation of non-performing loans.

WeWork’s downfall is reminding investors to value the math rather than the magic. Softbank is going to spend $10 billion bailing out WeWork and its CEO. WeWork’s bonds fell after the Softbank rescue was announced as existing bondholders are being relegated to second ranking. A potential bankruptcy of WeWork would cause significant losses in CMBS. Tesla recorded a profitable quarter by cutting costs faster than revenues fell and has built a Chinese car factory in 168 days. Tesla owners are posting videos of their cars going wild after using the “smart summon” feature. After 22 years of burning cash, Netflix is raising another $2 billion in debt. This cycle’s tech bubble is running out of helium. Silicon Valley held a conference to express their hatred for IPOs, right after several large tech company founders enriched themselves by listing shares that subsequently crashed.

India has strictly limited withdrawals from PMC Bank after allegations of fraud surfaced. Indian lenders are caught in a liquidity crunch with property developers the worst impacted. The default of Dewan Housing Finance could be a solvency shock for India’s banks. The law of the jungle applies to insolvency in India. Rating agencies in India are doing a poor job of predicting defaults.

Residential property sales have fallen hard in Beijing and Shanghai with commercial office vacancy rates well above international peers and rising. China has stopped publishing industrial employment data with alternative sources pointing to employers heavily cutting back on hiring. China has upped its infrastructure spending to offset a weakening economy. China’s foreign exchange reserves are falling as citizens use backdoor methods to get their money out.

A brief history of high profile corporate whistleblowers in the US. A former banker has given evidence that he received $45 million in kickbacks for helping arrange loans for companies in Mozambique. Seven global banks are accused of rigging the Mexican government bond market. American banks are shifting loans in disaster prone areas onto Fannie Mae and Freddie Mac. A former employee of Capital One talks about the ethical dilemmas they faced when selling high rate debt to subprime borrowers. 37% of Australian borrowers admit to lying on their loan applications. Silent second ranking loans have crept into Australian development lending.

Asset allocators get fee cuts by threatening to go passive, but they’d be better off switching to managers that deliver decent outperformance rather than sticking with mediocre managers. A review of academic studies over the last 20 years finds that active management has been judged too harshly. If you only consider their best ideas, active equity managers deliver substantial outperformance after fees. New research points to US equities outperforming bonds by only 1.7% over the last 220 years. Fund managers with higher employee ownership have stronger investment returns. Only 20% of emerging market debt managers beat their benchmark after fees. Ken Fisher made another batch of offensive comments at a financial conference, leading to his firm losing $3 billion in assets in 2 weeks. South Korea’s largest hedge fund has frozen investors after a redemption run.

Parts one and two of the early days of Blackstone. The firm that does the very boring work of normalising the errors in accounting rules. How brokerage firms make money when they don’t charge retail clients for trading shares. A quick introduction to the standards governing green bonds. Investors wanting ESG bond portfolios need to accept lower returns and concentrated holdings. A Reddit user bragged about turning $766 in $107,758 in a week by options trading. Virtue signalling CEOs are being cut down by their shareholders for underperformance.

Politics & Culture

The arguments that the allegations against Joe Biden’s actions on Ukraine are a conspiracy theory and the contrary side that says he has many questions to answer. Joe is telling TV networks to stop having Trump’s lawyer Rudy Giuliani on as a guest. Goggle is meddling in the US presidential election by suppressing information about Tulsi Gabbard. Elizabeth Warren is channelling Jussie Smollett with new evidence raising questions about her claim of being fired for being pregnant in the 1970’s. Mitt Romney used a fake twitter account to say nice things about himself and lob criticisms at Donald Trump. The ten most toxic donors, whose money has brought trouble onto those who received it. The Electoral College system is imperfect, but still the best way to elect an American President.

Trump’s properties gave different financial information to the government and their lenders. The allegations that groups are booking rooms at Trump’s hotels and never staying in order to curry favour. Trump’s campaign manager is as interesting and loose with the truth as Trump is. A Trump supporter pranked an Ocasio-Cortez event by saying ”we’ve got to start eating babies” to stop climate change.

South Africa’s racist government policies are holding it back from growing the economy. Where women see gender bias, men see a lack of women making the choices and sacrifices needed to get to the top. Voters in the all American stock research rankings are more likely to vote for women, even after adjusting for experience and performance. There are more men in STEM partly because men are so much worse at humanities than women. Several countries are allowing men to serve time in women’s prisons if they self-identify as female.

A US federal court judge has deemed legal Harvard’s blatantly racist admissions policies which include giving preference to kids that play expensive sports, dominated by wealthy white kids. Giving parents a choice of schools increases the quality of public and private schools. Technical/trade orientated high schools substantially increase the employment prospects and earnings of their students.

The NBA rejected Chinese bullying to fire a Houston Rockets employee for a pro-Hong Kong tweet. NBA fans mocked LeBron James for choosing Chinese money over free speech. China is spying on its citizens and feeding them propaganda through an app that is mandatory for government workers. China is requiring facial identification from its citizens to get internet access. The growing gap in China’s classes is setting up political discontent. A Chinese mayor was arrested after his home was raided and $660 million of gold was found. Chinese courts are denying divorce applications from women who are victims of domestic violence. Singapore has passed a law banning news the government doesn’t like with punishment of up to 10 years imprisonment and a $1 million fine.

An Ontario dental assistant lost his licence to practice after treating his wife. An Atlanta City Manager has shut down a preschool stall selling cheap vegetables in a poor neighbourhood for “zoning violations”. Swedish towns are requiring beggars to get a permit before hassling people for money. The German Parliament is considering jail sentences of up to 3 years for insulting the European Union anthem or flag. You can be fined up to $250,000 for using the term “illegal alien” in New York. US Police accused of stealing over $225,000 can't be sued after a bizarre court ruling. Americans are increasingly serving jail time for dodging their debts and refusing to appear in the subsequent court cases.

A Spanish court has handed down long jail sentences to nine Catalan leaders for pursuing independence. Canada’s government tried to block independent journalists from reporting on the election. The Australian government completely bungled an Interpol notice resulting in a refugee being jailed for 77 days. An Australian University is suing a senior academic for damages after he reported its alleged misconduct. Britain should leave the EU and join NAFTA.

Facebook has an unusually cosy relationship with the local police force covering its headquarters. Tech companies that think they are above the law are running into determined politicians and voters. Google is forcing companies to pay more to be highly ranked, including charging brands for their own names.

Dave Chappelle’s comedy special shows that ordinary people prioritise laughing whilst critics prioritise political correctness. An initial review of Stockton’s UBI experiment shows recipients could use financial counselling at least as much as the money. It’s odd that people like to wear t-shirts of the mass murderer Che Guevara. The FBI’s statistics show that handguns and knives are used in far more murders than rifles. Behind San Francisco’s homelessness epidemic lies drug abuse, mental illness and a lack of enforcement of basic standards.

Economics & Work

The winners of the Nobel Prize for Economics this year broke new ground in designing and testing programs to alleviate poverty. One of the Nobel Prize winner’s idea to pay poorer countries to take refugees could ease the global refugee problem. 5 economists who were in contention for the Nobel Prize.

Australia has had no official recessions but three per capita recessions in the last 28 years. Europe needs to undertake substantial economic reforms just like Germany did in 1948. 12 cutting quotes from Milton Friedman on government and freedom. Economists have consistently viewed the works of Karl Marx as shallow and illogical. Libertarians have gone on a cruise to share their disdain of Paul Krugman. Hungary, Poland and Serbia have railed against migrants but now need to import more to combat labour shortages. Americans with the lowest wages are seeing the biggest percentage wage gains.

After massive monetary and fiscal stimulus hasn’t delivered the desired levels of growth, there’s a growing call for helicopter money. Modern Monetary Theory has been tested in Latin America and it was a disaster. Japan is a perfect case study in the limits of fiscal and monetary stimulus. Six former European central bankers have written an open letter condemning the ECB’s ultra-easy monetary policy. Mario Draghi ignored advice from the ECB monetary policy committee not to restart quantitative easing. Swiss Cantons are taking drastic action to avoid the sting of negative interest rates.

Central bankers have self-assessed their use of unconventional monetary policy tools as a great success with minimal negative effects. Central bankers are mad professors running freakish monetary policy experiments on economies. After a decade of ultra-easy monetary policy, a global slowdown could bring a wave of defaults. The IMF has quietly admitted that easy monetary policy has provided the fuel for the next crisis. The increasing amount of debt creates a “bubble or nothing” economy, vulnerable to a long and deep recession. The argument over whether the latest batch of Federal Reserve bond buying counts as quantitative easing. Governments default regularly and we shouldn’t be surprised when they do.


US hospitals are detaining patients against their will and sticking them with the bill. A doctor explains how Americans are addicted to health care insurance. US family healthcare premiums have surpassed $20,000 per year. When healthcare costs are included in the calculations, America looks like a European welfare state. Walmart is revolutionising healthcare by offering basic medical services at a 30-50% discount. An American private equity firm auctioned off its graduate doctor slots at a distressed hospital. Sheriffs in Alabama frequently release sick inmates so they don’t stuck with the cost of medical care.

Ultra-processed foods trick our brains into thinking we need more food. The average human skull is shrinking, which negatively impacts sleep, weight and development. 30% of men and 86% of women in the US Army are failing the combat fitness test. Sleep deprivation is the biggest issue for NBA players. 5.7 million children in the US have a parent with addiction issues, so Sesame Street is introducing a character to help children deal with it.

A Chinese family went through 23 weddings and divorces in a month to get a bigger share of a property development. Five Chinese men are going to jail after four of them each subcontracted a contract to kill and the fifth contacted the target and asked him to fake his death. Hong Kong’s hotel rooms are being rented for as little as $9 per night as tourists stay away. China purged its internet of South Park content after an episode that mocks government censorship.

Celebrities that support action against climate change should jump on board the campaign to ban private jets. Dyson is shutting down its electric car project citing commercial unviability. Porsche is backing a Croatian electric car maker that makes Tesla’s performance look pedestrian. Climate activists gained infamy by botching their attempt to spray a government building red. London residents are fighting back against Extinction Rebellion protestors and the city has banned one of their protests.

Hydrogen has the potential to be the clean energy fuel of the future, with scientists becoming more efficient in using electricity to create hydrogen from water. Molten salt towers could be the cheap storage option that renewables are currently missing. Regenerating degraded soil could be a relatively cheap way to buy 20 years to address climate change. Wind and solar power are subject to very large swings in production on a daily and seasonal basis. The Sicilian Mafia is a big investor in wind farms.

Media companies used bots to submit millions of fake submissions to government inquiries. Match fixing has arrived for Esports. Credit Suisse had private investigators stalk a former executive to ensure he was following gardening leave protocols. A Utah woman has been charged with lewdness for temporarily being topless in her own home in front of her children. Instagram helped him build a steroid empire, the police sent him to jail for 10 years. The ongoing hunt for Asia’s biggest drug dealer.

Celebrating late bloomers; those who make a great impact in life after mediocrity early on. Open plan offices lead to less employee interaction. France offers its elderly citizens a low cost service for their postman to drop in and check on them. Granny flats are becoming the affordable housing solution. There are so many magazines about food, why not one about toilets? The ten deadliest foods in the world. Forbes is encouraging single women to travel to Taliban dominated parts of Pakistan. Qatar is working on outdoor air-conditioning in advance of hosting the Soccer World Cup. A New Zealand café is charging a $5 surcharge for “hipster allergies”. The man who makes public monuments dedicated to urban legends.

Jonathan Rochford
Portfolio Manager
Narrow Road Capital

Narrow Road Capital is a credit manager with a track record of higher returns and lower fees on Australian credit investments. Clients include institutions, not for profits and family offices.

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