It is now 15 days ‘till the general election! We see four apparent electoral scenarios (Democratic control of the House of Representatives does not appear to be contested): Republicans hold the Senate...
I gave you a brand new Ford, you said 'I want a Cadillac.'
I bought you a ten dollar dinner, you said 'Thanks for the snack.'
I let you live in my penthouse, you said it was just a shack.
- Performed by B.B. King
Talk about ungrateful! It appears that “Big Tech” stocks are not satisfied with the lowest yield on corporate debt ever. Nor are they content with the $100 billion of Treasuries and Agency Mortgage Backed Securities the Fed has been buying every month since the spring. Additionally, on their “things-we-should-be-grateful-for-but-aren’t list” is the Fed and Treasury facilities to purchase securities with some credit risk as well as corporate lending facilities. A lot of stockholders, bondholders, and Wall Street structured products desks are wealthier and happier because of the “Fed has our back” mentality created by these programs. Nevertheless, from Bloomberg News:
Big tech’s market-leading days might be numbered, thanks to Federal Reserve Chairman Jerome Powell. The NASDAQ 100 sank as much as 2.8% on Thursday, dragged down by a slump in the megacap technology stocks that have powered this year’s rebound. The slide came after Fed policy makers pledged to keep interest rates low until inflation averages over 2%, while failing to give any fresh details on the central bank’s bond-buying plans. Near-zero borrowing costs have helped to justify the industry’s lofty valuations, with the NASDAQ 100’s price-earnings ratio exceeding 40 before the latest selloff—the highest since 2004. That’s pushed the NASDAQ 100 up by about 58% from its March lows.
While we recognize that the mega-tech companies like Microsoft print money, don’t pay a lot in taxes, and are not relatively huge employers, it is very hard to deny that these companies’ equity valuations and borrowing spreads have been given a tremendous boost by the Fed’s largesse. Moreover, without the “Fed has our back” feeling, we doubt that cloud technology company, Snowflake, would have been able to launch an IPO this week with the end of day value of $70 billion. It may be the greatest cloud software company on the planet, but the valuation seems to suggest that it will be the only cloud software company on the planet until the end of time! We just do not see phenomena like this happening if the two-year Treasury note was at 2% as opposed to .135%. Blaming the Fed for the Big-Tech selloff makes us think of Veruca Salt from Charlie and the Chocolate Factory screaming about wanting an Oompa Loompa! If we remember correctly, Veruca turned into a giant blueberry (at least in the Gene Wilder movie version).
The good news is that one of equity analysts’ concerns was that the Fed, by not saying they would control the yield curve, and by announcing their “overshoot inflation” policy, technology companies would not will be able to borrow as cheaply as they have been this year. Microsoft borrowed $3.75 billion of 30-year money in the spring at a 2.675% yield. Currently, it yields about 2.36%. We would say that is pretty darn good for Microsoft and we also do not think that we are going to be worried about demand-pull inflation for quite a long time. If the Big-Tech companies’ stocks that led this market up crash, it will not be the Fed’s fault. Most probably, it will be the result of another crash in the financial markets, forcing investors to sell big and liquid winners.
Speaking of crashes, an area where there does not seem to be too much public handwringing is the commercial real estate (CRE) market. We think we should be terrified. In an interview with Bloomberg a few weeks ago, “The Father of CMBS,” Ethan Penner, said a very scary word about evaluating CRE: “Viability.” Viability used to be a concern when evaluating a speculative strip mall 30 miles out from Las Vegas in the desert. Now, it is being used for once-prime real estate. To make matters worse, because securitization is the norm for CRE, there are bondholders, as opposed to banks, that will remain to work through potential default situations. Bondholders outnumber banks by a lot, which makes workouts much more complex.
A colleague of ours is a special servicer for commercial real estate properties in the Southeast. Special servicers are entities that work out defaults on CRE. He reported to us that “very busy” for him used to be 15 projects at the same time. He reported to us that he currently has 50 on his plate. Hotels make up the most, but also retail and office space are making their way over. Additionally, B-Class shopping malls are seeing their default timelines (scary that even before COVID-19 there wasn’t so much as a probability of default for malls, but just a when!) accelerate. The spillover from a CRE crash will not be small, and it seems to be coming soon.
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