This week's interesting finds

 

This week in charts

S&P 500 outperformance

Magnificent 7

2025 interest rate cuts

Foreign exchange reserves

Imports from China

Tariffs

Household balance sheets

U.S. stock & bond correlation

Defaults on leveraged loans soar to highest in 4 years

US companies are defaulting on junk loans at the fastest rate in four years, as they struggle to refinance a wave of cheap borrowing that followed the Covid pandemic.

Defaults in the global leveraged loan market — the bulk of which is in the US — picked up to 7.2 per cent in the 12 months to October, as high interest rates took their toll on heavily indebted businesses, according to a report from Moody’s. That is the highest rate since the end of 2020.

The rise in companies struggling to repay loans contrasts with a much more modest rise in defaults in the high-yield bond market, highlighting how many of the riskier borrowers in corporate America have gravitated towards the fast-growing loan market.

Because leveraged loans — high yield bank loans that have been sold on to other investors — have floating interest rates, many of those companies that took on debt when rates were ultra low during the pandemic have struggled under high borrowing costs in recent years. Many are now showing signs of pain even as the Federal Reserve brings rates back down.

In the US, default rates on junk loans have soared to decade highs, according to Moody’s data. The prospect of rates staying higher for longer — the Federal Reserve last week signalled a slower pace of easing next year — could keep upward pressure on default rates, say analysts.

Many of these defaults have involved so-called distressed loan exchanges. In such deals, loan terms are changed and maturities extended as a way of enabling a borrower to avoid bankruptcy, but investors are paid back less. 

Portfolio managers worry that these higher default rates are the result of changes in the leveraged loan market in recent years.

Despite the rise in defaults, spreads in the high-yield bond market are historically tight, the least since 2007 according to Ice BofA data, in a sign of investors’ appetite for yield.

Still, some fund managers think the spike in default rates will be shortlived, given that Fed rates are now falling. The US central bank cut its benchmark rate this month for the third meeting in a row.

Some analysts blame loosening credit restrictions in loan documentation in recent years for allowing an increase in distressed exchanges that hurt lenders.

This week’s fun finds

The best music written about winter

In C.S. Lewis’s “The Lion, the Witch and the Wardrobe”, Mr Tumnus, a faun, laments that the White Witch has made Narnia “always winter, but never Christmas”—implying that only Christmas makes winter bearable. But the season offers other pleasures: skiing, if you enjoy elaborate dressing rituals; snowshoeing, if walking is not slow and cumbersome enough; or, best of all, staying inside and admiring the gelid landscape through thick windows, with a cup of something steaming. Here’s what to listen to during the short, frosty days and long nights (and not a carol on the list).

This week's interesting finds

This week in charts

MSCI EMU Index vs S&P 500 Index (minus NVIDIA) 

Equity allocation - U.S. vs. Eurozone 

Fund Manager Survey cash allocation

S&P 500 Index – Top 10 concentration 

EV/Sales greater than 10x

Tariffs

10-year yield move on FOMC Days

S&P 500 Index historical returns

Central bank tracker

Manufacturing vs. services

Monthly interest expenses

US Yield Curve Is Steepest Since 2022 After Fed’s Rate-Cut Shift

Longer-dated US Treasuries weakened Thursday, propelling the yield curve to steepen to a level last seen about 30 months following the Federal Reserve’s hawkish interest-rate easing and projections for fewer rate cuts next year.

The two-year yield was lower by 4 basis points to 4.31%, while the 10-year rose some 8 basis points to a session high of 4.59%, and was trading around the highest level since late May. That divergence in yields saw the two-year trade as much as 0.27 percentage points below the 10-year — a level previously seen in June 2022, with the yield curve steeper by some 11 basis points on the session.

The so-called steepening has been driven by a reticence among investors to own longer-dated Treasuries given sticky inflation and a resilient economy after the Fed has cut policy rates by 1 full percentage point in recent months. 

The benchmark 10-year note’s yield surged above 4.5% on Wednesday after the Fed indicated a pause was likely in the cutting cycle early next year and officials saw only two quarter-point rate cuts for all of 2025, given the lack of progress in bringing inflation down to their 2% target.

Reticence for Treasuries beyond the front end also extended to the inflation market. A $22 billion sale of five-year Treasury inflation protected securities at 1pm in New York attracted weak demand from non-dealers. The auction cleared at 2.121%, up sharply from a level of 2.05% leading into the bidding deadline.

The latest losses in the 10-year Treasury built on a steady losing streak that has driven its yield up from a low of 3.60% in mid-September. In that time, the 2s10s yield curve has turned positive after a prolonged period of inversion. 

The trend of preferring the short-end at the expense of the 10- and 30-year yields Thursday was maintained after data showed a slightly higher-than-expected upward revision to economic growth in the third quarter and after weekly initial jobless claims were weaker than forecast.

This week’s fun finds

After a successful term, our interns, Renae, Arrangan and Ramneek (not shown in the photo), served up a delightful flapjack breakfast for all their new friends at EdgePoint. We wish them all the best in the new year.

B.C. man drops camera into ocean, accidentally captures 'breathtaking' whale video

Before it turned into an extraordinary day, Peter Mieras says it began being quite ordinary.

The underwater videographer with Subvision Productions was trying to see if he could tie his new camera to an old fishing pole, so he could reel it in and out of the water. But then the line broke and the video camera sunk to the bottom of the ocean.

But before he could dive down to fetch it, a flock of birds and a herd of sea lions started feasting on a school of anchovies, just a few meters from the dock.

But then he captured the unexpected arrival of a humpback whale joining the hunt.

After two hours of witnessing in the wonder that was unfolding above the water, Peter retrieved that camera that had sunk, and was shocked to see what had been recorded under the sea.

“Failure is just another step towards success,” Peter says.

So why get frustrated when things don’t go according to plan? Things might just turn out even better than you could conceive.

This week's interesting finds

This week in charts

U.S. employment

U.S. & Canada high rise construction activity

MSCI region valuations

U.S. equity flows 

U.S. equity sector flows

Companies outperforming the S&P 500

Russell 2000 – Profitable vs non-profitable

Leveraged long ETFs

French stock market

U.S. power demand growth

Interest rates

U.S. government bonds

Global private equity

Tariffs are a misunderstood tool

If you want to understand the effects of tariffs on the economy, ask economic historians. Their views tend to be fairly nuanced, generally recognising that the history of tariffs is a varied one. Sometimes they are associated with higher economic growth and other times with lower.

For many economists, however, tariffs have become an ideological litmus test with little acknowledgment of these variations. Tariffs in advanced economies — and especially in the US — only matter, they argue, to the extent that they affect the prices of imported goods. For that reason, they are seen as always harmful to the economy because they always hurt consumers.

These economists are partially right about the effect of tariffs on consumption. That’s because tariffs, along with most other forms of trade intervention, are designed to lower the consumption share of GDP — the amount households consume of the total value of goods and services they produce.

This doesn’t mean however that tariffs necessarily reduce consumption. Like nearly all industrial and trade policies, they “work” by transferring income from one part of the economy to another — from net importers to net exporters, in this case. They do this by raising the price of imported goods, which in turn, raises the profits of domestic producers of those goods.

As all household consumers are net importers, while net exporters are producers of tradable goods, tariffs are in effect just a transfer from consumers to producers. They are both a tax on consumption and a subsidy to production.

So wouldn’t US tariffs — a tax on consumption — make American consumers worse off? Not necessarily. American households are not just consumers, as many economists would have you believe, but also producers. A subsidy to production should cause Americans to produce more, and the more they produce, the more they are able to consume.

Tariff policy is “successful”, in other words, if it raises domestic production by enough to pull consumption up with it — ie, if it causes Americans to consume more by producing even more. In that case American consumers are clearly better off, even as the share they consume of total domestic production declines. Of course, as production rises faster than consumption, this usually means that the trade deficit is declining.

On the other hand, tariff policy is a “failure” if it doesn’t cause a rise in domestic production, in which case tariffs reduce the consumption share of GDP mainly by causing consumption to fall. This would clearly make American consumers worse off.

If the US were to put tariffs on coffee, for example, these would likely prove a failure because Americans are unlikely to increase domestic coffee production except at a huge cost in other resources. As a result, domestic coffee production wouldn’t rise by enough to raise the total US production of goods and services.

If, on the other hand, the US was to put tariffs on electric vehicles, the relevant question is whether US manufacturers would be incentivised to increase domestic production of EVs by enough to raise the total American production of goods and services. If they are, American workers would benefit in the form of rising productivity. In turn, this would lead to wages rising by more than the initial price impact the tariffs had and American consumers would be better off.

This week’s fun find

EdgePoint has  officially moved! Huge thanks to Adam, Diane, Teresa, Matilde and everyone who had a hand in creating this new, beautiful space that we can call home.

The commas that cost companies millions

How much can a misplaced comma cost you?

If you’re texting a loved one or dashing off an email to a colleague, the cost of misplacing a piece of punctuation will be – at worst – a red face and a minor mix-up.

But for some, contentious commas can be a path to the poor house.

This week's interesting finds

This week in charts

S&P 500 Index drawdowns

Housing affordability

Canadian housing prices vs. income

Canadian exports to the U.S.

U.S. oil importers

China EV sales

Crypto funds

S&P 500 Index concentration

Magnificent 7

Entry price dictates returns

Not all European business is a profitless wasteland

Talk to European bosses about their continent and the responses are as varied as the languages they speak. Katastrophe, bark the Germans. The Italians wave their hands in exasperation. The French offer a resigned Gallic shrug. The British change the subject to the weather (which isn’t exactly fabulous, either). With governments collapsing centre-left (in Germany last month) and centre-right (in France on December 4th), plus war raging in next-door Ukraine, chaos is the political watchword.

European business can seem just as dysfunctional. In the past couple of weeks it has been a tale of bankruptcy (of Northvolt, a would-be battery champion), labour unrest (at Volkswagen, the continent’s biggest carmaker, where nearly 100,000 workers downed tools on December 3rd) and CEO defenestration (at Stellantis, a rival whose biggest shareholder, Exor, part-owns The Economist’s parent company). This week an activist investor ratcheted up pressure on Rio Tinto, the world’s second-most-valuable miner, to follow its bigger rival, BHP, in ditching its dual listing in London and settling for good in Australia.

Add a dearth of success stories in artificial intelligence (AI) and no wonder Europe’s chief executives are in a dour mood, made dourer by smug American counterparts whose companies, on average, sell more, turn fatter profits and are valued more richly by markets. The entire STOXX 600 index of large European enterprises is worth a third less than America’s “magnificent seven” technology giants. Shares of firms in the S&P 500, its transatlantic equivalent, trade at 23 times future earnings, far above the 14 or so eked out by STOXX constituents.

Even excluding the AI-fuelled trillion-dollar outliers, investors regard American businesses as more promising than European ones. The price-to-earnings ratio of the 493 firms in the S&P 500 that are not Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia or Tesla is comfortably higher than for the STOXX 600. As a Spanish CEO might put it, ¿Qué diablos?

These jarring disparities in aggregates and averages are real and troubling. However, they may conceal as much as they illuminate. Closer inspection reveals pockets of European corporate strength, some more surprising than others.

In specific areas of commerce, Europeans outmatch even those self-satisfied Americans, sometimes handily. Europe’s drugmakers are collectively worth more than American ones and boast twice the return on capital. Novo Nordisk of Denmark launched Ozempic before Eli Lilly began selling its weight-loss drug. Europe lacks an Nvidia, but the $3.5trn AI-chip designer would not get far without ASML, a Dutch firm whose machines etch Nvidia’s blueprints onto silicon. Ryanair and other European airlines fly rings around American carriers in terms of profitability. And nobody does posh better than the French (think LVMH) and Italians (Ferrari, also controlled by Exor).

An alternative way to look for winners among European companies is to ask what factors might shorten the odds of success. Consider how much a business spends on research and development (R&D). In Europe, the keenest fifth of R&D spenders, a group that devotes at least 12.5% of sales to that end and includes those pharma giants and ASML, outperform less enthusiastic ones when it comes to return on capital. No such regularity is evident in America, perhaps because corporate R&D budgets there are generally higher relative to revenue to begin with.

European companies have two other things going for them. Many have patient shareholders, whose interests are aligned with businesses’ long-term success. For 237 of Europe’s 500 most valuable listed firms, at least 10% of stock is not freely traded (not counting state-controlled enterprises). Plenty of those stakes are in the hands of founders or, this being the old continent, their descendants. For America’s top 500 the equivalent figure is 90.

The other advantage is low expectations. Frothy American valuations may tumble, especially if AI fails to boost productivity in line with investors’ hopes. Sagging European ones could improve merely by reverting to the mean. Bon courage!

This week’s fund find

‘Brain rot’ named Oxford Word of the Year 2024

Our language experts created a shortlist of six words to reflect the moods and conversations that have helped shape the past year. After two weeks of public voting and widespread conversation, our experts came together to consider the public’s input, voting results, and our language data, before declaring ‘brain rot’ as the definitive Word of the Year for 2024.

Our experts noticed that ‘brain rot’ gained new prominence this year as a term used to capture concerns about the impact of consuming excessive amounts of low-quality online content, especially on social media. The term increased in usage frequency by 230% between 2023 and 2024.