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Category: News & Articles

The Fed is primed to cut rates next month.

Thanks to a situation straight out of their playbook:

You have a rare line up of: the Fall-Guy (the US BLS reported earlier this week that there were 818,000 fewer Non-Farm Payroll jobs than originally reported; the unemployment rates for May, Jun, Jul at 4%, 4.1% and 4.3% are the highest ever since Jan 2022); and the Stumble-Guy (the CPI prints for May, Jun, Jul were at 3.3%, 3% and 2.9%).

So, it all hunky-dory then and the case is made for the first rate cut?

When viewed strictly against its dual mandate of ‘maximum employment’ and ‘price stability’, the Fed appears to have closed this out. Afterall, CPI YoY prints of 3.3%, 3% and 2.9% are indicative of ‘price stability’.

But the Fed’s widely anticipated pivot next month does not come without a shadow of a doubt.

Here is an exercise to help you determine that ‘shadow of a doubt’:

Step 1: Type in www.bls.gov in your browser search bar

Step 2: This is the landing page of the fall-guy (contains information about the stumble-guy as well). Your task is to locate another little guy ─ The CPI Inflation Calculator.

Step 3: Plug in $100 in the first cell; Jul 2020 and Jul 2024 in the next two set of cells

Step 4: Click ‘Calculate’; you should see $121.40 on your screen.

In effect, you need $21.40 more today to match your Jul 2020 purchase.

That number ─ $21.40 ─ is the shadow of doubt that I was referring to earlier.

True, the Fed may point at price stability and say: Mandate achieved, Job done.

But has it done enough to restore the considerable loss in the USD’s purchasing power (PP) post-pandemic?

Let’s anchor a number to this: the annual avg CPI index value for 2020 was 259; for 2024 YTD its 312.

Which means the USD has lost about 17% in PP since the pandemic.

Is PP even a factor that could sway the Fed next month?

I don’t know.

The Fed commentary has traditionally remained anchored to price stability (the initial monster spikes in inflation that lift the base value of the CPI index ─ setting back PP (often permanently) in the process ─ are usually not referenced)

But Powell’s Fed is in a sweet spot today to tackle this post-pandemic loss in PP.

With an economy that’s continuing to grow. A job market that’s showing strains, but still holding up well. A disinflationary trendline that’s broken 3%. And finally, the silver bullet: a sticky 2+% real interest rate.

Has the PP of the USD ever increased?

It did.

Was in a different era though. When there was a Gold Standard.

Between 1929 – 1933, the PP of the dollar increased due to (1) deflation (there were 4 consecutive annual CPI YoY readings of 0.6%, -6.4%, -9.3% and -10.3%) and (2) a near 30% contraction in the money supply.

The last time the US registered a negative inflation print was in 1954 when the CPI Index deflated by 0.7%

So, what’s it going to be next month?

A pyrrhic victory?

Or a rare new narrative that balances duties towards both price stability and PP?

By

Avinash Menon, CFA

Founder and CEO,

52 Seconds Capital Limited

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I recalled a couple of unsettling incidents from the past today.

From Dec 2012 to be precise.

On Dec 14, 2012, a mass shooting occurred at the Sandy Hook Elementary School in Connecticut. The perpetrator, a 20-year-old shot and killed 26 people. 20 of the victims were children between 6 and 7 years old.

My older girl had just turned a year old at the time, and I still remember, despite being thousands of miles away from the scene of the tragedy, how raw and visceral the horror felt.

Prohibit Guns! That idea played on a loop in my mind.

And yet, that loop was broken within a 48-hour window when, on Dec 16, 2012, the Nirbhaya case rocked the collective conscience of India.

I found myself wondering: She should have been armed. Not with a knife. Not with a taser. But with a loaded firearm.

Gun ownership in the US is legally protected by the 2nd amendment to the US Constitution. So, the dilemma here isn’t really something along the lines of Gun Ownership Vs. Prohibition.

Gun Ownership ─ even after the assassination attempt on Trump yesterday ─ in the US isn’t going away anytime now.

But a narrow window to moderate the gun culture has possibly opened yesterday.

For starters, consider how dense gun ownership is in the US:

1. The Small Arms Survey (SAS), undertaken in 2018, stated that American civilians account for an estimated 393 million (about 46%) of the worldwide total of civilian held firearms or about 120.5 firearms for every 100 American residents.

2. The share of US households owning at least one firearm has remained steady since 1972, hovering between 37% and 47%. In 2023, about 42% of U.S. households had at least one gun in their possession.

You see the problem now; guns are an essential small white-good in US households. And ownership has been generational and sticky across time.

It’s also clear that the US gun culture is an outlier to the rest of the world. (As is their firearm homicide rate: at 4 per 100,000 people, the US has the highest firearm homicide rate in the developed world!

For comparison, Indonesia with a population of 280 mio has a near zero gun-ownership for every 100 civilians. Mexico is at 13. UK and India at 5. (Source: SAS 2017)

With such an entrenched gun culture, where exactly is that window to moderate that I referred to earlier?

Well, not surprisingly, US politicians have made earnest efforts to repeal existing gun regulations, not when Sandy Hooks or mass shootings have happened, but when one of their own ilk was the target.

Kennedy’s assassination led to the passage of the Gun Control Act,1968.

The Brady Handgun Violence Prevention Act,1993 was passed after an attempt to assassinate Reagan.

My guess is the first signs of moderation could come with a renewed total ban on Assault Weapons (The Federal Assault Weapons Ban enacted in 1994 expired in 2004). Refer image to get an idea of how things stand now. This survey was undertaken between Jan 27 – 29, 2023.

By

Avinash Menon, CFA

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52 Seconds Capital Limited

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Is there a point in doing ‘pointless’ things?

Like Sisyphus, the character from Greek mythology, who continuously rolled a boulder up a steep hill.

Or the merry men who rearranged the deckchairs on the Titanic.

Or the FTSE Russell’s annual reconstitution (see image for the sequence of events) of its Russel 3000 index.

This index reconstitution is an event that’s, metaphorically speaking, both Sisyphean ─ in terms of its time loop, the inaugural Russel reconstitution first occurred exactly four decades ago in 1984; as well as Titanic-sized ─ since the Russell 3000 index tracks the stocks of the 3,000 largest companies listed on the U.S. stock market and includes about 98% of all American stocks.

Index providers typically have two key duties: Rebalancing and Reconstituting.

The former poses no problem, since most US indices are value-weighted (except the pointless Dow Jones which has remained price-weighted since inception, but that’s a story for another day on ‘dumb-indices that refuse to go away’), it’s the latter that increases complexity.

You see, an index like the SPX 500 is rebalanced every quarter, but companies can be added and deleted (which is the Index Reconstitution process) at any point in time.

What makes the Russell 3000 index reconstitution exercise complex is it’s only done once a year!

Considering the sheer breadth of the index, it’s tough for Russell 3000 stocks to be buffered out of the index on-the-go or even for the index to be reconstituted at quarterly frequencies.

There is some market chatter that FTSE Russel is considering changing the reconstitution frequency to semi-annual (to reduce the trading pressure on the markets considering the recon trade now sizes up to at least $100 billion)

But even a semi-annual recon exercise only adds more shelf space to the pointlessness of the entire exercise since the Russell 3000 ─ while admittedly being more objective than the SPX ─ also ranks stocks based on Market Cap, effectively creating an index with a long tail that tapers down to include stocks with a minimum market cap of $30 million.

Does that effectively represent a broad swathe of the US market?

Those series of revolving doors at each break in market cap sizes between the Russel 1000, 2000 and 3000 did have some Hedge Funds interested in the spoils of Index Arbitrage trades for a while but most of those Hedge Funds have now exited this strategy.

The superfluous breadth of the Russel 3000 appears most ungainly when viewed against the MSCI World Index which captures large and mid-cap representation across 23 DM countries.

MSCI World is a world index, yes.

And it has 1,465 constituents.

By

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Remember the Repo Crisis of Sep 2019?

Overnight money market rates had spiked and showed significant volatility, with the SOFR spiking up from 2.43% on Sep 16 to 5.25% on Sep 17. (Refer image; Source: www.federalreserve.gov)

The largest money market in the world had just experienced an unsettling liquidity squeeze! (.. a situation that was then only alleviated after the Fed announced an overnight repo operation, to be conducted on the morning of 17th, offering up to $75 billion against USTs and other govt. bonds as collateral).

The events of Sep 2019 would ultimately only serve as a precursor to the biggest liquidity shock ever experienced in the US treasury market ─ the dash-for-cash in March 2020.

Which might prompt you to think: Why would the biggest fixed-income market experience liquidity outages?

Consider this: The Fixed Income Clearing Corporation (FICC) is the sole clearer of Treasuries and at present just 13% of cash treasury trades go through it!

That’s a staggeringly low percentage; and does make the UST market vulnerable during periods of heightened stress.

Here’s how:

Presently, a large volume of cash treasury trades is bilaterally cleared: which means each party assumes a counterparty risk of the other and the settlement is directly between the two parties.

You can see straightaway the risk this form of clearing poses during a period of market stress.

What if one of the counterparty defaults?

And imagine the subsequent domino effect it could create on the world order.

The SEC has identified this [bilateral clearing] as a clear-and-present danger for liquidity seizing up in the UST markets and have rung in changes that would force larger volumes of trades through a Clearing House.

And how does a Clearing House reduce counterparty default risk?

Think of a Clearing House as an entity that sits between a buyer and seller in a trade and takes collateral from both to safeguard each party’s interests.

It’s not all hunky-dory though for all market participants: forcing a larger volume of trades through a Central Clearing House means the SEC has taken the axe to Hedge Funds running strategies related to basis trades ─ usually 100x levered trades that bet on a convergence in the prices of Treasury Cash-Futures.

Hedge Funds may not really have the same appetite for Basis Trades, since they will now be required to post cash as collateral.

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In July 2023, the Federal Reserve and other top US regulators, unveiled its own ‘gold-plated’ version of the Basel III norms.

The proposal was, almost immediately, heavily criticised by the US banking industry for going far beyond the Basel accord.

A closer look at some of those regulatory proposals do indicate that the US banking regulators might have overreacted (especially on the ramping up of risk weights on residential mortgages). But some of them ─ related to model and operational risks ─ are spot on despite the criticism, especially when viewed in the context of the failures of Silicon Valley Bank, Signature Bank and First Republic Bank.

All that in a while.

But first, the back story.

***

The Basel III guidelines were introduced in response to clear breaks in the regulatory apparatuses around the world during the GFC of 2008.

The crux of the Basel III norms is the CET1 ratio, which in simple terms is the ratio of the bank’s core capital over its risk-weighted assets.

The lower this ratio, the weaker a bank. And vice versa.

Refer image for capital requirements of large US Banks. (Source: www.federalreserve.gov)

***

Back to the July 2023 proposals from the US Banking Regulators:

While the proposal does not explicitly raise required capital ratios, it does so anyway through its impact on RWAs.

Consider, Residential Mortgages:

Currently, first-lien loans prudently underwritten, receive a 50% risk weight, while other loans receive a 100% risk weight.

Under the draft proposal, residential mortgage risk weights are set to be 20% higher than international standards.

Think about that: the increased mortgage risk-weights against the backdrop of US mortgages currently tipping the scales at $12.14 trillion (at close of Q3, 2023, source: LendingTree), representing about 70% of the US consumer debt.

Now you get an idea why the proposals have raised the industry’s hackles!

This is clearly an area that might get watered down when the US Banking Regulators release an amended draft.

But there are a couple of points in the current draft that could remain unchanged.

For one, the advanced approaches for calculating RWAs (currently used) could well be replaced with the expanded risk-based approach. Particularly since it looks to standardize the approach towards credit, operational and credit valuation adjustment (CVA) risk.

The other one, among others, that could stay ─ in a classic case of closing the stable doors after the horse has bolted ─ is the removal of the ‘AOCI opt out’ (SVB had opted out of the Accumulated Other Comprehensive Income (AOCI) requirement and hence none of the unrealized losses from its available-for-sale securities, largely USTs, were included in its capital).

While awaiting the regulator’s revised draft, safe to say that the US Banking Industry is on tenterhooks, sweating buckets, while enduring the long wait until August ─ a month fittingly referred to as summer’s last stand.

By

Avinash Menon, CFA

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In a year dominated by elections worldwide, it is fitting that The Walt Disney Company took the crown for the most expensive corporate proxy fight ever.

The bruising battle ended with Disney’s management claiming a resounding victory over activist investor, Trian Fund Management, L.P.

The results of the voting process confirmed a long-held belief among financial market participants: asset mgmt titans Vanguard (V), BlackRock (B) and State Street (SS) wield enormous influence over the outcomes of the proxy voting process.

Despite the Asset Managers’ roll out of reforms like ‘voting choices’ and ‘pass-through voting’, the results of the vote indicate that millions of investors aren’t yet fully immersed in the voting process (Between them, V and B, on behalf of retail and inst. investors, ‘own’ 14% of Disney’s shares)

The results may have come as a surprise to long-term Disney shareholders simply because the points made by Trian appeared to be strongly in their interest.

Here is a summary of them:

1. A broken CEO succession process

2. Disney’s abrupt elimination of dividends in 2020, after 57 straight years.

3. While the Fox acq. moved the needle on revenues (from $59 bio in 2018 to $88 bio in 2023), costs escalated as well. Operating margins have plummeted from ~ 25 % in 2016 ~ 6% in 2023.

4. There is also a damning comparison with streaming leader Netflix that shows up Disney’s execution gaps.

These are compelling arguments from an activist pitching for a board seat, yet the results were one-sided in favour of the incumbent mgmt and board.

Is there any other explanation for this?

Something that sits outside the realm of balance sheet objectivity?

To answer that question, you must look closely at how events panned out at another proxy vote.

Recall that 3 years ago, ExxonMobil (XOM) was defeated by Engine No. 1, in a climate-charged activist battle.

Know what was unusual then?

B, V and SS voted against the XOM management and backed the activist hedge fund.

In an odd twist in that tale, last year, Engine No 1 unanimously backed Exxon in its $60 billion bid for Pioneer.

Know what that means?

It means XOM made a $60 billion fossil fuel bet that had the support of an activist who won its board seats on the back of a climate change campaign.

XOM, which is up 20% YTD, has executed well on its shareholder outcomes this year (with the Pioneer acquisition meaningfully lowering extraction costs)

And therein lies a possible explanation.

Exxon was up against ‘woke’. Lost the vote. But won the war eventually.

Disney has possibly won this on a ‘woke’ plank (Trian’s ‘Restore the Magic’ deck makes all the right points and, on the deck, when I did a CTRL+F on ‘Woke’ nothing came up, yet their [Trian’s] narrative got sidetracked in that direction thanks to a barrage of interviews that appeared ‘Anti-Woke’).

If only Trian had stuck to balance-sheet objectivity …. and left the anti-woke battle for a different day.

By

Avinash Menon, CFA

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As the first quarter of this year winds down, it appears that ‘scarcity’ has emerged as a key investment factor.

The contrast is sharper when viewed against the environment of ‘excess’ ─ characterized by federal cheques, central bank stimulus and unfunded tax breaks ─ that was being engineered by Central Banks and Govts worldwide at around this same time, four years ago.

Cut to present and you see a rare inversion in the investing environment: despite the twin backdrop of easing headline inflation and the highest Fed rate in 22 years:

1. Gold has spiked ─ up 5% YTD …

2. … and Bitcoin has shot up 60% YTD

Is it the scarcity of these asset classes that’s driving this surge? Or is there more to this than meets the eye?

(As an aside, there are some nice examples this year of ‘product scarcity’ driving up returns in some select equities as well this year, my favourite is Ferrari, up 25% YTD, sporting a monstrous 27% operating margin, but that’s a story for another day 😀)

On the face of it, scarcity does appear to be the reason for the surge.

Scarcity falls into 3 categories: demand-induced, supply-induced, and structural. Let’s stay here with the first 2 of those and map it to the two major success stories of this year.

Gold is witnessing a demand-induced scarcity.

But it did not provide for any military aid.

Central Banks worldwide bought over 1,037 tons of it in 2023. The final figure for 2023 was marginally shorter than the estimated 1,136 metric tonnes purchased in 2022 ─ a record year!

And this buying is not being led only by the G7 nations and PRC (Turkey was the biggest buyer in Jan 2024).

Gold’s supply dynamics hasn’t changed radically (See image, Source: Statista)

Bitcoin is witnessing a rare confluence though of demand-induced (spurred by the SEC largesse to approve Bitcoin ETFs early this year) and supply-induced scarcity (ahead of the halving, expected next month).

These arguments strongly corroborate the scarcity factor.

But what if there is a stronger signal here that is getting missed out?

Confiscation?

Central Banks worldwide have been wary ever since the US and EU confiscated Russian foreign reserves.

Nah, you say! That’s just extrapolating a one-off event.

Not really.

In another March, a couple of decades ago, in 2003, the then US president, George Bush Jr, issued an executive order to confiscate Iraqi assets held by U.S. financial institutions and vest them in the U.S. Treasury.

This perhaps explains the Central Banks’ frenzied purchase of Gold over the last couple of years.

What about Bitcoin then?

Central Banks haven’t bought in (at least not yet!). What then explains the retail/institutional frenzy around it? Is it only scarcity? Or is there a confiscation angle to this one as well?

Well, here is the thing.

Gold held by a Central Bank cannot be confiscated.

But Gold held by individuals can be.

No way, you say!

Well, it has happened.

Among others, the US did it in 1932. Australia in 1959.

Bitcoin isn’t confiscatable.

By

Avinash Menon, CFA

Founder and CEO,

52 Seconds Capital Limited

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I guess no one really enjoys reading a Red Herring Prospectus (RHP).

Those reams of paper make for dry reading and could put anyone to sleep.

In the investment management industry, however, it’s an occupational hazard 😀 There is no getting away from it.

That said, there is the occasional RHP that I look forward to reading.

In the recent past, I recall one such SEC filing that made for an interesting read: Coinbase’s RHP (some spoilers here in case you plan to revisit it : the landing page, Page 1, of the prospectus mentions Satoshi Nakamoto and his Bitcoin Address 1A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa, Page 19 of the RHP states this as a risk factor: the identification of Satoshi Nakamoto, the pseudonymous person or persons who developed Bitcoin, or the transfer of Satoshi’s Bitcoins)

The key point here is this: reading the RHP is necessary, especially if the company in question is pioneering a new paradigm.

Uber, Google, Groupon are possibly some other examples that come to mind.

So, yes, in that context, I look forward to reading SHEIN’s RHP.

The Chinese company, a pioneer in fast fashion, is stitching up a blockbuster IPO, with plans to go public this year.

The company’s business playbook relies on an immediate absorption of market demand at a response speed that makes ZARA SA (the original pioneer of the adaptive strategy in fashion) look a tad slower.

Shein is on a tear, posting revenues of $23 billion and $30 billion (expected) in 2022 and 2023.

A valuation of $70 billion to $80 billion at 2.5x sales looks a given.

The business is riding a wave of popularity among shoppers: Shein was the second most downloaded shopping app of 2023 (trailing Temu and ahead of Amazon; see image, Source: Statista)

What could be of interest then in their RHP?

Lawsuits!

Specifically, allegations that Shein counterfeits products made by its peer firms.

Plaintiffs range from firms like H&M to several small business owners.

It’s tough to surmise what might be written on this subject on those pages.

Shein might either detail their plans to counter the allegations of counterfeiting.

Or that they might just acknowledge that counterfeiting has existed for ages.

And they have just added scale to an age-old practice.

Bringing counterfeiting to the mainstream.

By

Avinash Menon, CFA

Founder and CEO,

52 Seconds Capital Limited

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Ukraine was signaling donor fatigue towards the end of last year.

And with good reasons.

The US, after directing more than $75 billion (see image) in aid between Jan 2022 and Oct 2023, wasn’t keen to continue support in what was to be an election year.

With the EU it was a bit more complicated (as you would imagine in a 27-nation bloc, it is never going to be easy!).

There was cohesion around continuing aid but the form of EU aid ─ whether financial, humanitarian or military ─ often saw cross currents; and large gaps remained in commitments vs. allocations, especially on military aids.

And so, late last year, faced with a $43 billion budget deficit in 2024, Ukraine was looking down the proverbial barrel.

Until this month changed that.

On Feb 1, the EU finally announced a $54 billion aid to Ukraine.

It wasn’t all smooth sailing though, with the lead up to the agreement seeing stiff opposition from Hungary (on financial and military aid) and from Slovak (halting military aid).

Now here’s the surprising bit: the $54 billion package will support Ukraine’s economic rebuild ─ Ukraine’s economy contracted by 29% in 2022 ─ by providing predictable funding all through until 2027 and ensures that the country (hopefully) will not need to print local currency to fund its ongoing war.

But it did not provide for any military aid.

That changed when earlier this week, NATO’s Secretary General made a stunning announcement: 18 out of the 31 NATO members will spend at least 2% of their GDP on defense in 2024.

It’s a telling sign that the NATO announcement came a day after the Biden administration, on Feb 13, passed a $95.34 billion military aid (whose chief beneficiary was intended to be Ukraine) in the US Senate.

Will this $95 billion funding bill pass the Republican-controlled House?

It just might? (thinks the Biden administration).

And what if it does not? (thinks the NATO).

Ergo, the NATO’s aggressive dialup of its defence budget is the strongest sign yet ─ of the EU preparing for a Trump administration in the White House by close of this year.

By

Avinash Menon, CFA

Founder and CEO,

52 Seconds Capital Limited

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Read More
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On January 31, 2024, the New Development Bank (NDB) ─ a lender established by the BRICS nations in 2015 ─ issued a RMB 6 billion ($845 million) 5-year Panda Bond ─ a bond from a non-Chinese issuer sold in Mainland China ─ in the China Interbank Bond Market. With the Jan 2024 debt raise, the total issuance of Panda Bonds by NDB, since its inception, is RMB 47.5 billion ($6.67 billion).

The NDB debt raise comes on the back of a record year for Panda Bond issuance in 2023 ─ Deutsche Bank, the governments of Egypt and Poland, and the National Bank of Canada among other raised RMB 150 billion ($21.1 billion).

Bond issuers know a price arbitrage when they see one.

NDB’s panda bond was priced at 2.66%! (the 5-year UST is at 4.126%)

Ah, but the CNY has weakened you might say?

Indeed, the CNY has weakened by about 14% since March 2022 (which is about when the US Fed started raising rates) but it’s held its own rather well against the twin, tempestuous backdrops of the USD yield differentials and the PBOC’s massive easing measures.

The Chinese regulatory environment is also a lot more benign now.

Since December 2022, the PBOC and the State Administration of Foreign Exchange allows Panda Bond issuers to repatriate proceeds overseas.

There is another factor at play here ─ China’s M2 money supply.

While the US has seen its M2 money supply contracting thanks to the Fed tightening its balance sheet, China’s M2 money supply ─ increase in M2 leads to an increase in demands for bonds ─ has on the other hand been edging up steadily (see graph, China @ M2 of $41.5 trillion Vs. US @ M2 of $20.95 trillion, also China’s M2/GDP is 2x, nearly twice that of the US).

The gap between China’s M1 and M2 money supply remains wide (the PBOC did point out the significant jump in the M1 YoY growth of 5.9% in Jan 2024 Vs. growth rates that largely remained in the 1%-2% range for most of H2 2023 as ‘signs’ that the stimulus is working, but in absolute terms M1 is still only at $9.55 trillion at close of 2023 and trails M2 by a wide margin) and is indicative of liquidity that’s available but held tight-fisted.

Is that a recipe for a deflationary spell in the world’s second largest economy? (That’s perhaps a story for another day and hinges upon what the Chinese playbook for stimulus could eventually look like)

Doesn’t matter, the point here is deflation kindles the interest of bond holders, especially in long duration bonds.

So, if you combine that massive pool of Chinese M2 liquidity with global sovereign and corporate borrowers who ─ balking at multi-decade high USD rates ─ are looking at cheaper ways to raise debt, you will see why Panda Bonds are perhaps at the very beginning of a long runway that’s opening up.

By

Avinash Menon, CFA

Founder and CEO,

52 Seconds Capital Limited

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