This is the first weekly newsletter post here at Credit Writedowns. And this iteration will be a mash-up of the daily, with a few issues that are in the business in finance news plus a sneak peek at what I think are some key issues to watch out for.
As I iterate these newsletter posts, the format may change. Let me know if there’s something you want to see or don’t want to see.
Cheers,
Edward
1 Big Thing: Tesla needs help from its suppliers
I have been writing a decent amount about Tesla of late because the company’s business trajectory seems to be in transition. The most recent example of the change is a memo that asks its supplier to refund a significant portion of the money Tesla has paid them since 2016.
This is a highly unusual move, especially given the fact that the rationale Tesla offered for the suppliers’ showing such generosity was that it would help Tesla become profitable.
Why this matters: Tesla is at a crossroads now as the company recognizes it can no longer depend solely on external funding to expand. Last month, it did a restructuring, laying off 10% of its workforce to help move toward profitability. And while the reaction to the restructuring was mostly positive, this request for money back from suppliers could make Tesla look like a company in trouble. After many recent provocative and erratic public displays from Tesla CEO Elon Musk, investors are becoming nervous.
Deeper take: Tesla could be in trouble.
The cracks are starting to show, with some commentators in the mainstream press turning against Tesla. Just yesterday, the New York Post ran a story entitled “Elon Musk is a total fraud” that questioned whether he had ever succeeded in any business venture:
Musk has been in business since 2002. His stated goal is nothing short of transforming humanity through his products: his electric cars, space travel, and an underground high-speed Hyperloop system.
He has yet to succeed at anything but somehow spins every failure into proof of imminent success. His only accomplishment has been this decades-long Jedi mind trick.
Tesla is best known for blowing deadlines and consistently falling short on production.
Given the change in sentiment toward Musk specifically and Tesla as a company, the next two earnings reports will be critical. If Tesla cannot meet production and financial targets, investors will question Tesla shares and Tesla debt and sell.
2. Earnings season volatility?
And it’s a potentially uneven earnings season that could derail investor sentiment, which has seen the S&P 500 rally 5% this year.
Why this matters: Goldman Sachs is telling clients that there are so many moving parts driving stocks that investors could be surprised by large volatility this earnings season. They note that earnings day volatility had already been trending higher over the past three years. But now Goldman says we have stronger growth, tax changes, and inflation concerns to contend with just as the volatility implied by stock option prices is at an 11-year low.
Contrarian take: Volatility tends to rise the most when investors least expect it as people are forced to reposition their investments. When the dust settles, people then re-examine their portfolios in earnest and start asking questions they hadn’t before the bout of volatility. Market darlings like Tesla could face even more scrutiny in such an environment.
3. Trump’s Fed choices
One area that Goldman didn’t mention that could drive volatility is the Fed. President Trump has begun to criticize the Fed for raising interest rates. Yet, ironically, when Adam Ozimek of Modeled Behavior looked at Trump’s picks, he concluded that all of Trump’s Fed picks were hawkish.
Why this matters: the tilt of the Fed is now potentially more hawkish than it was before Trump became President — because he has made it so.
If Trump wanted a low interest rate policy, the time to get it was when he picked a new Fed chair. Instead, the pool of candidates Trump chose from basically included the status quo, Fed hawks, and someone from his administration..
[Trump Fed candidates] Yellen and Powell were going to generally stay the course on relatively gradual rate hikes. This was known by anyone who cared to ask, and Trump should have been fully aware of this. Warsh and Taylor are obvious monetary policy hawks who would have increased rates even faster. Why a president who wants low rates would even consider them is beyond me.
Deeper take: Interest rates will continue to rise if the economy stays robust. We know that from what Fed officials are telling us. What’s more, at least two of Trump’s other four Fed nominees are hawks: Marvin Goodfriend and Randal Quarles. The other two, Michelle Bowman and Richard Clarida are middle of the road but not dovish. So Trump has actually aided the policy he is complaining about.
This outlook is exactly the reason to be concerned about the Fed over-tightening.
4. Record $2.5 trillion mergers in first half of 2018
I haven’t seen this statistic get much play in the media, but we saw record M&A activity in the first half of the year. More than $2.5 trillion of deals were announced, surpassing the previous first half record in 2007.
Why this matters: The animus for much of the merger activity is defensive as companies try to prevent FAANG (Facebook, Amazon, Apple, Netflix and Google) companies from encroaching on their space. But M&A activity is arguably a contrarian signal, reaching previous record levels in 2000 and then again in 2007 as two booms turned to bust.
Deeper take: The media deals are certainly defensive and tech-related. But the other area where we see lots of deal-making is healthcare. And here, it is rising operating costs and lower reimbursements that are the big factor. We are in the midst of a secular consolidation in healthcare provisioning. The defensive tech-oriented mergers will die down if this cycle ends. But, in healthcare, the cost issues will continue to drive more consolidation. See Forbes for their take on this issue.
5. The trade war is affecting Chinese M&A
Speaking of M&A, look at what’s going on with China. A year ago there were $7.5 billion of deals involving Chinese companies in the US. This year, there was only $1.5 billion of merger-related activity involving Chinese actors in the US.
The Chinese did $53 billion of deals outside China in the first half of 2017. And this figure went up to $76 billion in 2018. The US was the number two market in 2017. This year it was number eight.
Why this matters: Clearly the trade war is having a chilling effect on Chinese investment in the US. The dip in Chinese investment could be temporary. But the rhetoric coming from the White House suggests the trade (and now currency) war with the Chinese has legs. So we should expect the reduction in Chinese investment in the US to continue.
6. What to watch for in the week ahead
- Earnings calendar: A lot of numbers are coming out this week. The big name on Monday is Alphabet (Google). There will be a host of banks as well. I would watch Whirlpool too given the trade issue. Facebook reports on Wednesday and Twitter on Friday. I think the AT&T and Comcast reports and earnings calls on Tuesday will be interesting as well.
- Economic calendar: I don’t think it’s a big week until Friday. We’ve got PMIs on Tuesday and Michigan Consumer data other than the usual weekly stuff. That’s about all that I see significant on the earnings calendar until we get the GDP number. I expect big numbers as consensus estimates now are for 4.1% with the inflation index at 2.4%. That’s going to get the Fed in high gear.
- Trade and Trump/Russia: So I expect earnings, trade issues and the Trump-Russia headlines to continue to dominate the news cycle. Next week, when we get the GDP number, people may come to refocus on economics and the Fed, especially if we do get numbers as big as the consensus estimates.
That’s all I got for now.
Edward
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