This week's interesting finds

Some profitable companies would still pay no taxes under Democrats’ plan

The Democratic proposal approved this month by the House Ways and Means Committee would sharply raise taxes on U.S. corporations, and business groups are working hard to defeat it. The legislation would increase the top corporate tax rate to 26.5% from 21%, and remove many benefits of booking profits in low-tax foreign countries.

The bill, however, doesn’t touch the main reasons why profitable companies sometimes don’t pay taxes, including accelerated depreciation of investments and tax credits for activities such as research and development.

The legislation also expands tax credits for clean energy and low-income housing in ways that could allow some companies to move from paying little to paying nothing.

The bill moving through Congress represents an explicit choice by Democrats to tolerate some zero-tax companies and steer tax advantages to companies that engage in favoured activities.

 

When the levee breaks…

To a man with a hammer, every problem looks like a nail. To the Federal Reserve, every problem is met with more liquidity. Unfortunately, the Fed has little control of where this liquidity goes. First, it went into equity markets, fueling an outright equity bubble. Then it overflowed into private equity and venture capital, creating demons there as well. Then it overflowed into “meme stonks” Not satisfied with the damage wrought on the financial economy, liquidity began overflowing into the real economy. There’s currently an epic housing bubble that’s leading to increasing wealth inequality and polarization.

Now, this liquidity is overflowing into the everyday economy—assuming you can even find the item you seek. In the past, only hard money zealots complained about the gradual creep of inflation—today, everyone feels it and has their own story. Everyone is painfully aware that inflation is present and likely to stay.

Could the bubble in duration assets (like high-multiple tech and Ponzi) finally be over? Could the bubble in inflation assets just be starting? Could the unwind of both historic extremes be unusually violent, as so much of the world’s capital is leaning the wrong direction? 

Climate change ETFs found to be undermining war on global warming

Climate-focused investment funds are undermining the fight against global warming by routinely engaging in greenwashing, academic research suggests. Worse still, these ETFs keep capital away from sectors that are actually at the heart of the transition to a cleaner economy.

“Since considerable investment is necessary to ensure electrification of the economy and decarbonisation of electricity, underfunding of this sector in climate-aligned benchmarks, which can correspond to a reduction in capital allocation of up to 91 per cent, would constitute the most dangerous form of portfolio greenwashing,” said Felix Goltz, co-author of Doing Good or Feeling Good? Detecting Greenwashing in Climate Investing.

“The key issue is not how to restrict investment in these industries, but rather, how to make sure that these industries invest in technology that allows them to produce needed goods and services with minimum release of greenhouse gases,” he argued.

The findings come as investors have poured money into funds that claim to improve the world. The assets of self-proclaimed “sustainable” funds tripled between the end of 2018 and mid-2021 to $2.3 trillion, according to data from Morningstar.

Belize leans on coral reefs to drive bargain with bondholders

Belize is inching towards a deal with international bondholders after admitting it cannot afford to pay back its debt, and is counting on an unusual asset to help: its coral reefs.

Earlier this month the Caribbean nation, with its tourism-heavy economy ravaged by the pandemic, agreed to buy back its only international bond from investors at a huge discount, using cash lent by the Nature Conservancy, a US-based environmental group. As part of the deal, Belize will pre-fund a $23.4m endowment to support marine conservation projects on its coastline, home to the world’s second-largest barrier reef

If Belize can achieve the approval it needs on this $530 million bond, the country could secure the first green-tinged debt restructuring, capitalizing on the hunger among big fund managers to demonstrate their commitment to environmental, social and governance-driven investing.

Investors and advisers believe the agreement could serve as a template for future restructuring talks, in which cash-strapped nations use the promise of environmental conservation to drive a harder bargain — in effect creating a mechanism for investors in rich countries to pay poorer nations to protect the natural world.

Podcast: Dan Wang explains what China's tech crackdown is really all about

Over the last several months, Chinese authorities have undertaken a sweeping campaign of change. We've seen crackdowns on big tech and fintech companies (like Ant Financial and Didi), online education companies, and now even the playing of video games. Investors in key sectors have been clobbered by these new rules.  

This week's interesting finds

This week’s charts

Media usage trends

Trends in vehicle type purchases 

ICE (internal combustion engines) - traditional engines, powered by gasoline, diesel, biofuels or even natural gas

HEV (hybrid electric vehicles) - powered by a combination of an ICE and an electric motor 

BEV (battery electric vehicles) - no internal combustion engine or fuel tank at all and runs on a fully electric drivetrain powered by rechargeable batteries   

Europe’s energy crisis  

European power prices have spiraled to multi-year highs on a variety of factors in recent weeks, ranging from extremely strong commodity and carbon prices to low wind output. 

The October gas price at the Dutch TTF hub, a European benchmark, was seen to climb to a record high of 79 euros ($93.31) a megawatt-hour on Wednesday. The contract has risen more than 250% since January, according to Reuters, while benchmark power contracts in France and Germany have both doubled. 

Earlier this month, soaring gas prices and low wind output prompted the U.K. to fire up an old coal power plant to meet its electricity needs. 

“If there was enough wind, it could maybe meet more than half or two-thirds of U.K. power demand on a relatively low power demand day. But instead, what we are seeing is that actually we’ve got no wind and we are forced to fire up polluting coal-fired generation.”

Production wall setting us up for all-time high oil prices  

The world is hurtling towards an energy crisis, one in which the demand for oil, in my opinion, will grow for at least the next decade, yet the global oil supply chain can no longer adequately respond to it due to stringent environment, social and governance regulations and pressure from investors. 

How did we get here? Energy ignorance: the lack of knowledge of how oil is used, how critical it is to our daily lives, and the realistic timeline to replace it with a “renewable” alternative lie at the epicenter of the coming energy crisis. 

With the world’s population set to grow by another two billion people according to the United Nations by 2050, and oil alternatives such as hydrogen expected to take several decades to reach meaningful scale, once OPEC spare capacity gets exhausted by the end of 2022 and ESG pressures continue to disallow production growth from the equivalent of 40 per cent of global supply, I would posit the question: where exactly are incrementally necessary barrels going to come from in sufficient quantity in the years ahead to meet demand growth? 

This is our energy reality: the runway to displace oil as a transportation fuel is measured in decades while the ability to reduce oil consumption in non-travel related areas would require a meaningful reduction in the average person’s quality of living — a choice that will not be made willingly.

Digital retail businesses are betting on brick-and-mortar  

Retail darlings Warby Parker and Allbirds launched on the internet and paved the way for other brands to follow their playbooks and hope for similar success. The two businesses have become synonymous with the term “direct-to-consumer” in the retail industry. The strategy involves avoiding wholesale channels, such as department stores, to forge stronger relationships with customers. 

Now, they’re betting big on real estate — not the web — to fuel future growth. While opening up stores comes with added fixed costs, brick-and-mortar retail remains the best channel to find new customers. Warby Parker and Allbirds are betting on shops as they prepare to go public.

“There’s a certain phase of your infant growth where you can achieve success without stores, and it can be really easy to acquire customers,” Jason Goldberg said. “But no digitally native brand has achieved a billion dollars in annual revenue without a store. You need those stores as a cost-effective customer acquisition channel at some point.”

This week's interesting finds

This week’s charts

There have never been more job openings in the US before

Who has the real pricing power?

Investors willing to take on higher risk debt while losing money relative to inflation  

Investors in European junk bonds have begun accepting interest payments that are lower than eurozone inflation levels for the first time ever. Analysts said investors’ willingness to extend credit to the riskiest borrowers while losing money in real terms reflected the scarcity of other opportunities to earn returns in debt markets. 

Some investors may be inspired to buy junk bonds because they believe some issuers’ fortunes could improve to the point they would obtain investment-grade ratings.

Credit rating agencies have been upgrading bonds from junk status at an unusual rate with €7bn of European high-yield issues having been pushed up to investment grade in the past 12 months. This stands in contrast to the average €7bn worth of bonds that had been downgraded in each of the past five years, on average.

Equities and inflation  

This chart shows the correlation between the 12-month real equity return and the 12-month change in the inflation rate, for quintiles formed by the starting inflation rate. Only in the lowest quintile (starting inflation rate less than 1.0%) is the correlation positive at 0.4. In all other cases, there is a negative relationship between the real equity return and inflation changes, and more so for higher starting levels of inflation. The trend suggests that equities actually benefit from rising inflation if the starting level is low, but are hurt by rising inflation if it is above median (increased risk of inflation escalating).

The Case for a longer-term oil and gas bull market  

Back in mid-2020, folks were pronouncing the energy sector dead. Now, oil and gas companies in the US shale industry, and more broadly among publicly-traded independent oil companies, are on track to make record free cash flows in 2021: 

Historically for two centuries now, whenever humanity finds a better energy source, we add it onto the previous energy sources, rather than replace them. The previous energy sources remain flat or even continue to grow in absolute terms, while the new one grows faster and becomes more important:

This week's interesting finds

Field crops

Statistics Canada released its annual crop production forecasts. The numbers were expected to be down sharply because of a lack of rain, higher than normal temperatures and low soil moisture levels to begin. This was not a big surprise for the market, however year over year declines were large, nonetheless.

Rent increase

Car inventory at multi-decade low

Crackdown on ESG labels

U.S. regulators have long said they’re dubious about the green and socially conscious labels that Wall Street applies to $35 trillion in so-called sustainable assets. For several months, SEC examiners have been demanding that money managers explain the standards they use for classifying funds as ESG-focused. The review is the SEC’s second into possible ESG mislabeling since last year - showing the issue is a priority for the agency and a reason for the industry to worry about a rash of enforcement actions.

Few businesses are booming in high finance like sustainable investing, as governments, pension plans and corporations all seek to lower their carbon footprints and be better public citizens. Amid the rush for dollars, more and more ESG insiders have started sounding alarms that a lot of the marketing is hype, a term known in the industry as greenwashing.  

The fund industry has said one problem is that no one really agrees on what qualifies as sustainable investing. Since March, European money managers have had to disclose the actual ESG features of products being touted. In the U.S., no such mandate exists - prompting confusion among financial firms and investors alike.

Still, any murkiness over rules and requirements isn’t insulating firms from criticism.

InfluenceMap, a London-based nonprofit, said last week that more than half of climate-themed investment vehicles aren’t living up to the goals of the Paris Agreement.

Why Fund Returns Are Lower Than You Might Think

Morningstar’s annual "Mind the Gap" study of dollar-weighted returns (also known as investor returns) finds investors earned about 7.7% per year on the average dollar they invested in mutual funds and exchange-traded funds over the 10 years ended Dec. 31, 2020.

This was about 1.7% less than the total returns their funds generated over that span.

This shortfall, or "gap," stems from inopportunely timed purchases and sales of fund shares, which cost investors nearly one sixth the return they would have earned if they had simply bought and held.

Good news: The most popular material on Earth is great for storing CO2

Concrete is the most used material of the modern era. More than 10 billion tons of concrete are produced each year. Luckily, scientists are showing that it’s our most promising place to stick all of that CO2, too.

CO2 enters the atmosphere whenever we burn fossil fuels, like gas and coal. Once it’s made, it sticks around because CO2 has a stable structure that requires energy to change. Depending on exactly what you want to turn CO2 into, that can take more or less energy.

When CO2 is incorporated into concrete, it’s literally piped into the mix. The natural tumbling motion of churning concrete is all the energy that’s needed to transform the CO2 into a calcium carbonate. All of this tough calcium carbonate means the concrete needs less cement in its mix, which is another environmental savings, since cement is the worst polluting component of concrete.

This week's interesting finds

This week’s charts

Shopping online? 

Cash Hoarders   

EV effect on oil consumption  

As of July, 64% of the cars sold in Norway are electric. It hits the IEA’s target for ‘Net Zero’ scenario set for 2030. However, the country’s oil consumption is surprisingly unchanged. Here are some of the reasons: 

• Cars account for about 20-25% of global oil consumption Which dilutes impact that EVs have on total oil demand 

• While the new EV car sales are high the total number of EV cars on the road is under 10%. It takes significant time to turn over the fleet. 

• Oil usage for non-passenger car purposes has increased in a last decade due to increased number of vans and trucks. 

• LPG/ethane consumption which mostly used for petrochemical plants or for space heating and cooking increased by 31%.   

Rules, Truths, Beliefs 

• The line between bold and reckless is thin and often only visible with hindsight, so be careful who you admire and what you admire them for. 

• Few things are more persuasive than the opinion you desperately want or need to be true. 

• Average returns sustained for an above-average period of time leads to extraordinary returns. 

• Price drives narrative and narrative drives price, so crazy things can last a long time. 

• Investors as a group don’t learn from booms and busts because when people say they’ve learned their lesson they underestimate how much of their previous mistakes were caused by emotions that will return when faced with similar circumstances. 

• It’s easy to ignore the power of tail events because it’s painful to accept that most of what happens isn’t that important. 

• “Be more patient” in investing is the “sleep 8 hours” of health. It sounds too simple to take seriously but will probably make a bigger difference than anything else you do.   

Canadians are paying off nonmortgage debt  

• Overall non-mortgage debt fell by a record $20.6 billion from the start of the pandemic to January 2021, including a $16.6-billion drop in credit card debt 

• Mortgage debt, however, rose by a record $99.6 billion over the same period. 

• The largest reductions in debt loads were among those with the lowest credit ratings 

• The change came as household consumption spending dropped significantly, down 14.7 per cent in the second quarter last year compared with a year earlier 

• The debt repayments have also come about as government support programs helped prop up incomes and, in some cases, paid more than what people had been earning before 

• People with the lowest credit scores also generally face higher interest rates. Any extra dollar that they have, it’s a huge saving to be deleveraging and paying down that credit card.

Fukushima water 10 years later 

Tokyo Electric Power Company Holdings Inc. plans to construct an approximately 1 kilometer-long undersea tunnel to release treated radioactive water from the crippled Fukushima Daiichi nuclear power plant out to sea. 

The level of the radioactive substance tritium that remains in the treated water will be diluted to below regulatory standards 

The decision to release it offshore into the Pacific is aimed at preventing reputational damage to local marine products amid an outcry from fishermen. 

The Japanese government said the same day it will buy marine products as an emergency step to support fishermen if the planned discharge of treated water from the Fukushima plant into the sea hurts their sales.

This week's interesting finds

This week’s charts

Hard market conditions continue with the U.S. Property & Casualty rate growth trending at high single-digit range for 12 consecutive months 

Shortest corrections

Since we broke through the 2007 pre-GFC highs in the summer of 2013 we are now looking at more than 320 new highs in this bull market. Which means in the past 7 years US stock market has reached a new high once out of every 7 days or so.

The difference between this cycle and the last is that corrections did not last very long, while crashes in early 2000s were measured in years instead of months.

How the US tech giants could fall  

American tech companies lead the world’s top 10 by market value and many commentators and investors see no reason to question their continued dominance. The conventional narrative is that these giants are growing bigger, faster and more durably than their predecessors

Only we have seen much of this before.

Data going back to 1970 shows companies that finished a decade in the top 10 saw median earnings gains of around 330 per cent over the course of that decade, and their stocks beat the market by more than 230 per cent. The top 10 of the 2010s were not that different from the norm: earnings were up 350 per cent and their stocks outperformed the market by 330 per cent.

Since 1970, companies that finished a decade in the global top 10 have had a less than one in five chances of finishing the next decade there.

Capture more value  

Switzerland-based Vestergaard introduced its LifeStraw technology, which removes 99.99999% of bacteria and 99.9% of protozoan cysts from contaminated water. The product is a favorite of aid organizations: Over the past decade, LifeStraws have been distributed after almost every disaster.

But not every place with bad drinking water is a relief zone; 780 million people in the world lack access to clean water in their daily lives. So Vestergaard saw a much larger potential market than its NGO customer base—and proved that it could innovate in another way. The challenge was LifeStraw’s cost, which is beyond the means of most households in developing countries. The company found a clever means for families to fund their purchases: with carbon offset credits. Thanks to the worldwide carbon emissions trade, any documented C02 savings can now be monetized—and using LifeStraws means not having to burn petrol or wood to boil dirty water. Vestergaard’s Carbon For Water initiative has enabled hundreds of thousands of Kenyan families to pay for its product, growing its business substantially.

Both these kinds of innovation—one in value creation, the other in value capture—are important. But most companies focus only on the first.

To benefit from both kinds of innovation, companies need to think about value capture more imaginatively and as a matter of course.

This framework shows 15 ways firms can capture new value, clustered under five focal points of change. 

A Framework for Value-Capture Innovation

The rise of warehousing  

The demand for warehouse space is pushing industrial real estate into new terrain, and Canada may have limited warehouse space by the end of the year, thanks to the surge in e-commerce sparked by the pandemic. 

Statistics Canada reported retail e-commerce sales were up 110.7 % year-over-year to $3.5 billion in January 2021. 

Online splurging by Canadians is estimated to reach $92.7 billion by 2025 and net-new warehouse requirements from e-commerce-related pressure are expected to exceed 40 million square feet over the next five years.

This growth is more significant than all the available leasable space in Canada’s three largest industrial markets combined.   

Bets against Cathie Wood’s ARK Innovation ETF  

Ms. Wood’s ARK Innovation ETF raced higher in 2020 and at the start of 2021, boosted by big bets on companies like electric car maker Tesla Inc., Roku Inc. and Square Inc.

But as shares of technology and other fast-growing companies lost some of their luster over the following months, so, too, did Ms. Wood’s innovation fund. It is down 6.9% this year, while the S&P 500 has risen 18%

Several hedge funds took out fresh positions in the second quarter betting against Ms. Wood’s actively managed ARK Innovation exchange-traded fund, according to the most recent 13F filings.

Mr. Burry’s Scion Asset Management held bearish put options worth nearly $31 million against 235,500 shares of the ARK Innovation ETF. Laurion Capital Management held roughly $171 million worth of put options against 1.3 million shares of the ARK Innovation ETF. GoldenTree Asset Management, Moore Capital Management and Cormorant Asset Management also held sizable bearish positions on Ms. Wood’s fund.

This week's interesting finds

This week’s charts 

China

Source: Bank of America

Correlation of yields and styles

*5Yr rolling correlation; monthly change in US 10-yr yields vs outperformance to S&P 500 (TR) ANALYST TEAMSource: Scotiabank GBM Portfolio Strategy, Bloomberg.

Producer Price Data (PPI) as a measure of inflation 

Unlike the CPI report, producer price data surprised to the upside. The Producer Price Index (PPI) is a measure of inflation based on input costs to producers.

Is Inflation Here to Stay?

The August 1979 BusinessWeek issued a magazine with cover line “The Death of Equities — How Inflation is Destroying the Stock Market” in which it outlined how inflation would depress equity returns for a generation of investors. 

In retrospect, this was probably the worse market call ever made.

The funny aspects of business magazine cover stories is that in the short term they are perceived to be correct. It was not until August 1982, three years after the publication of the BusinessWeek article that investors suddenly recognized the financial landscape had dramatically changed. The stock market exploded off the bottom on August 17th and never looked back.

Two years have passed since BusinessWeek/Bloomberg’s 2019 “Is Inflation Dead?” piece and we believe we are rapidly approaching inflation’s inflection point.

Multiple fundamental trends now confirm this view: 

o  In 2019, money supply was only growing at 4% per year; today it is growing at 27% per year — the fastest rate in history. In 2019, the Federal Reserve’s balance sheet stood at $4.3 trillion compared with $7.3 trillion today. In 2019, US government debt totaled $20 trillion. Two short years later, it stands at $28 trillion — up 40%. 

o  Over the last year, the US government has borrowed and spent $2.4 trillion to replace $800 billion of lost economic activity resulting in a US savings glut of nearly $1.5 trillion. Not content with the massive surge in government spending, the Biden administration is proposing an additional $3 tr in stimulus spending. 

o  With the economy now starting to recover, the press is filled with stories of shortages that have developed in countless markets from lumber to semiconductors to restaurant workers to ketchup packets.   

Mixed reviews  

• From farm to bottler to supermarket cooler, a liter of Coca-Cola creates 346 grams of carbon dioxide emissions, the company’s data show. That’s less than half the tree-to-toilet 771-gram carbon footprint of a mega roll of Charmin Ultra Soft toilet paper, as measured by the Natural Resources Defense Council, an environmental group. 

• Math like this is fast becoming obligatory. Investors are increasing pressure on businesses to disclose the emissions of greenhouse gases related to their products and services. Regulators are starting to ask about that, too. Within the next couple of years, every public company in the U.S. might well be required to report climate information. 

• Investors are eager to buys stocks that rank high on ESG factors. A Wall Street Journal analysis of ESG grades issued for nearly 1,500 companies by three rating firms found that nearly two-thirds—942 companies—got different grades from different raters. 

• Nearly a third of the companies were deemed ESG leaders by one or more rating firms, but labeled ESG laggards by one or another rater. Credit ratings, by contrast, are broadly consistent.   

Wealth inequality

• Americans may be richer than they think and less unequal than they’ve been led to believe. 

• There are strong reasons to include pension and Social Security guarantees in wealth calculations. Most workers forfeit 12.4% of their income annually in payroll taxes in return for Social Security payouts starting in their 60s, but that wealth is ignored in standard inequality measures. 

• In the 40 to 59 age group that is the paper’s focus, the top 5% of households control 63.5% of “market wealth”—liquid assets, housing, and accounts like 401(k)s. But include future pension and Social Security income, and the top 5% share is a more modest 45.4%, the authors find.   

Simple Explanations For Complex Topics  

One of the biggest residential real estate brands in the world, Zillow, is getting hammered in the midst of one of the biggest housing booms we’ve ever seen? What gives? 

• Some claim this was the market’s acting as a forward-looking indicator showing the housing market is going to crash. This one doesn’t pass the smell test. Other housing-related stocks are crushing it this year.

• Another theory was that this is a housing boom in price only. This makes sense considering how low inventory levels are. On the other hand, part of the reason for this is houses are flying off the shelves. Existing home sales are higher than they’ve been in a long time. 

• If it’s not the industry and it’s not a company that’s falling out of favor the next logical guess would be valuation. This is an argument that seems to hold water. The price to sales ratio was well over 13x in the February blow-off top, twice the average over the past 5 years. 

There are a number of stocks with similar return profiles. Stocks that are still up a lot from the lows of the Corona crash, despite being down a lot from their highs. 

Sometimes there is a good reason stocks get cut in half. Sometimes there is a good reason stocks rise 500% in a matter of months. 

We would all like for there to be a simple explanation for complex topics like the movements of stocks in the short run. But most of the time these price moves are random, an amalgamation of emotions, differing opinions, expectations and momentum.