The Capital Note

The Capital Note: Blue Waving (or Drowning?)

Democratic presidential candidate Joe Biden speaks during a campaign event at United Association Plumbers Local 27 in Erie, Pa., October 10, 2020. (Kevin Lamarque/Reuters)

Welcome to the Capital Note, a newsletter about business, finance and economics. On the menu today: Stocks and a “blue wave,” ultra-low rates and rising risks, fleeing to Uruguay, vaccine-vulnerable stocks, the value of “green jobs” (spoiler: not much), and ghosts and real-estate prices.

Betting on Biden
In yesterday’s Capital Note, Daniel reported that Wall Street was hoping for a “blue wave,” and quoted this extract from a note by Goldman Sachs:

In the event of a blue wave, we believe Democrats would likely pass a sizable COVID-19 relief package on the order of $2.5tn (12% of GDP) in Q1 2021, legislation to boost infrastructure by a few hundred billion dollars over the next five years, and a broad “reconciliation” bill in Q3 2021 that would provide new benefits in several areas, such as healthcare, and would probably also include tax increases to offset increased spending. We think a larger Democratic Senate majority, of around 53 or 54 seats, might also lead to the elimination of the filibuster, which would ease the passage of major legislation and increase the probability of changes to regulatory rules, anti-trust laws, and the minimum wage.

That may well be correct but reading that last sentence made me wonder whether (beyond the benefits of a stimulus package, at least in the short-term) investors should be quite so enthusiastic. It is hard to believe that, under the circumstances of a Democratic sweep, the passing of “major legislation” (stimulus apart) will be a plus for American business as a whole, although there will certainly be winners. The same goes for tougher antitrust laws, which are, except in some egregious cases, merely an exercise in central planning dressed up in (supposedly) market-friendly form.

When contemplating tougher antitrust action, there’s something else to contemplate, particularly if it’s directed at the high-tech giants. To repeat myself repeating myself:

Enthusiasts for anti-trust action against big tech (I’m not one of them) might want to think through the implications for their 401ks, as this argument contained within a recent article by Bloomberg’s John Authers suggests.

“The performance of the NYSE Fang+ index continues to be barely believable. It has outperformed the equal-weighted version of the S&P 500 by almost exactly 100% over the last 12 months.

Now that the biggest five stocks in the S&P account for 22% of its market cap, a problem for them could also mean a problem for the S&P itself…”


Equally, a resumption of the regulatory ratchet that has been partially reversed in the Trump years is unlikely to be helpful to business (again, as a whole: Thus increased climate change regulation won’t hurt stocks of companies seen as winners from a switch into “clean” energy.)

And in the event of a Democratic sweep, it seems reasonable to expect that no small part of Biden’s tax agenda will also be put into place, an agenda that includes a substantial increase in corporate taxation (which to look at things purely mechanically, will hit corporate bottom lines, and thus, by reducing earnings and dividend capacity increase valuations—if those are your measures— still further). Also promised, an increase in capital-gains tax, something that will, amongst other consequences, effectively, if indirectly, increase the cost of capital (and may also trigger a tax-driven sell-off before year-end).

That said, the prospect of a Democratic sweep (I’m making no predictions about this, merely reporting what investors appear to be thinking) is calming worries that the U.S. may be facing the prospect of chaos in the weeks after the election, although writing in the Wall Street Journal, Gunjan Banerji notes:

Other traders caution anxiety surrounding the election hasn’t dissipated entirely, and the VIX has remained elevated even as stocks have climbed this month. On Monday, it jumped to the highest level since early September.

Even some investors who had piled into exchange-traded funds that would benefit from a victory for Mr. Biden appear to be hedging their bets. Solar stocks and other alternative energy shares had surged in recent weeks, partly thanks to the expectation that they would benefit from Mr. Biden’s $2 trillion package to combat climate change.

But bearish put options outstanding tied to the Invesco Solar ETF recently surged to the highest level of the year, Trade Alert data show, while the fund fell the most in a single day since March. Such contracts allow investors to sell the shares at a given price, later in time and are often used as hedges.

There are, of course, blue waves and bluer waves. While I wouldn’t be surprised to see stocks rally in the event of a Democratic sweep (largely on the back of stimulus hopes) smarter investors will, I suspect, be looking carefully at the composition of that majority. 51-49, say, with moderates holding the balance may be one thing, but a larger majority where some of the more right-leaning Democratic moderates can be safely ignored may be quite another.

Debtors’ Prism
I’ve written before and will doubtless be writing again about the way that current ultra-low interest rates distort the investment process.

From the Financial Times a couple of days ago:

Rather than punish the profligate and push borrowing costs higher, the scale of demand from investors for sources of income has easily absorbed the corporate debt deluge. Even with a rising tide of defaults, benchmark yields for speculative rated companies have recovered impressively from a peak of 11.4 per cent during March market stresses towards a more comforting 5.2 per cent, according to Ice Data Services.

One can hardly fault the logic of investors when central banks are backstopping credit markets and encouraging the buying of risky assets. With government bonds yielding less than zero across Europe and below 1 per cent for a US 10-year Treasury note, some argue that owning high-quality corporate debt ticks the boxes for being a “safe” asset while offering a more attractive fixed rate of interest.

Central banks are not shy about reminding us that investors are operating in a world where the normal rules do not apply. Earlier this week, an official at the Federal Reserve Bank of New York discussed the various credit market facilities launched in March and indicated there was a willingness to ramp up purchases of corporate bonds “if market functioning measures indicate deterioration.”

Columbia Threadneedle Investments estimates that among the non-financial investment-grade companies they cover globally, they expect net debt in the US to exceed 2 times earnings before interest, tax, depreciation and amortisation by year end. That would represent a steady increase from 1.16 times in 2009. For Europe, the fund manager forecasts it to be 3.1 times by the end of the year, up from 2.5 times in 2009.

The bill for this year’s debt binge beckons once the pandemic abates. It can only hold back an economic revival when companies focus on cost-cutting at the expense of investing and hiring staff.

Now think about the implications for the economy when companies are forced to cut back at the same time as governments are (presumably) trying to restore some sort of order to their chaotic finances.

Somehow, I think that the only roaring in these twenties will be roars of pain.

And via Bloomberg (my emphasis added):

Three cents. Two cents. Even a mere 0.125 cents on the dollar.

More and more, these are the kinds of scraps that bondholders are fighting over as companies go belly up.

Bankruptcy filings are surging due to the economic fallout of Covid-19, and many lenders are coming to the realization that their claims are almost completely worthless. Instead of recouping, say, 40 cents for every dollar owed, as has been the norm for years, unsecured creditors now face the unenviable prospect of walking away with just pennies — if that…

While few could have foreseen the pandemic’s toll on the economy, the depth of investors’ pain from corporate distress was all too predictable. Desperate to generate higher returns during a decade of rock-bottom interest rates, money managers bargained away legal protections, accepted ever-widening loopholes, and turned a blind eye to questionable earnings projections. Corporations, for their part, took full advantage and gorged on astronomical amounts of debt that many now cannot repay or refinance.

It’s a stark reminder of the long-lasting repercussions of the Federal Reserve’s unprecedented easy-money policies. Ultralow rates helped risky companies sell bonds with fewer safeguards, which creditors seeking higher returns were happy to accept. Now, amid a new bout of economic pain, the effects of those policies are coming to bear.

And those ultra-low interest rates still persist today.

And you don’t even want to think about what will happen to corporate and national budgets if they start to rise.

This won’t end well.

I cannot help wondering if at some level all this has something to do with the recent rise in the bitcoin price. Writing in Marketwatch, Mark DeCambre offers up other explanations, but take a look at the whole article, not least to savor this quote from Warren Buffet. Buffet’s politics may be questionable, but he has a way with words. Apparently, he referred to bitcoin and its ilk as “rat poison squared.”

Around the Web
Moving along rapidly from all that gloom, let’s travel rapidly (and almost certainly foolishly) to Argentina, where taxes are causing people to run for the exit.

The Financial Times:

Affluent Argentines have long favoured the chic Uruguayan beach resort of Punta del Este, often escaping the stifling summer heat in Buenos Aires to its wide sandy beaches and Atlantic surf.

But with a leftist government in Argentina ramping up taxes on the rich while a new conservative administration in neighbouring Uruguay offers tax breaks to newcomers, many wealthy Argentines are choosing to move across the river Plate permanently.

“I don’t want to work for the next 15 years when I’m at the peak of my earning capacity in order to be able to enjoy my retirement, only to have to give it all back to the state,” said one Argentine executive in his fifties who relocated to a beachside villa near Punta del Este this year. “Uruguay is no tax haven . . . but Argentina is a money trap.”

One of the biggest causes of discontent is what many see as a confiscatory tax system. Congress is set to soon debate a one-off “solidarity” tax on Argentines with net assets of more than $3m that officials say could raise up to $4bn.

That is on top of an existing wealth tax that was raised in December to 2.25 per cent — higher than any other country except Spain. It increases the burden on taxpayers even further in what is already one of the world’s most heavily taxed countries.

Nothing like that could happen here, of course.

Selling off on peace fears.

There’s an almost certainly apocryphal story that when, after the signing of the Munich agreement in 1938, shares in the British company, Vickers, which had a sizable armaments division, sold off, a newspaper headline ran:

Vickers shares fall on peace fears.

In that spirit, Marketwatch:

These are the stocks to short when a COVID vaccine is ready, says JPMorgan.

“Litter Jobs.”

Andy Kessler in the Wall Street Journal:

Most green jobs are not productive jobs. They’re public-works projects…that raise the price of energy. I know: In California, energy is 52% costlier than in the average for states. That’s negative productivity. How bad could it get? Gina McCarthy, CEO of the Natural Resources Defense Council, told Bloomberg, “Well if you asked me how much I would spend on clean energy in the future for our kids, I’d say all of it. That’s my price tag.” Yikes.

Jobs for jobs’ sake never works. If we put aside productivity we might as well have an economy of hand-washing each other’s laundry. Or digging canals with spoons. But washing machines and backhoes are more productive, with fewer people. Adding insulation is not productive. It only vaporizes resources created by those who are productive.

Random Walk
A handy reminder that markets can be driven by the unreal as well as the real from Utpal Bhattacharya, Daisy Huang, and Kasper Meisner Nielsen writing in the Review of Finance:

To examine the effect of haunted houses on prices, we follow a standard approach in real estate economics and regress the logarithm of the transaction price per square foot on time-varying unit characteristics, unit fixed-effects, and year-month fixed effects. We find that the haunted unit drops in price by 19.9% after it becomes haunted; the units in the affected floor drop in price by 9.7%; the units in floors 1 to 3 floors above or below the affected floor drop in price by 8.9%; the units in the affected block drop in price by 7.1%; the units in the affected estate drop in price by 1.4%. Local economic shocks in Hong Kong cannot explain this highly granular ripple effect within an estate.

The researchers conclude that demand shock rather than fire sale supply shock explains most of the effect.

Ghosts, of course, do not exist (Don’t @ me: I grew up in a series of very old houses, and for decades I have had to put up with my family’s astonishment at my refusal to believe in ghosts), but in Hong Kong, “haunted” has a precise meaning:

A legitimate issue is how we define a haunted house. In Hong Kong, a haunted house is where an unnatural death occurred.

This is believed to cause “excess negative energy.”

On reading this, my instinct was to fly to Hong Kong and pick up an apartment that had been the scene of a peculiarly bloody killing (a murder drives prices down more than any other type of “unnatural death.”)

But that would not be wise. In Hong Kong vendors are apparently obliged to disclose whether a property is, according to the local definition, haunted, and there’s a reason for that:

Price recovery is slow. We find that prices of the haunted units do not seem to recover during our 16-year sample period. The prices of its affected neighbors on the same floor do recover, albeit very slowly.

Do read the whole thing, fascinating not only in its own right, but as a tale of markets and pricing.

H/t: Marginal Revolution.

— A.S.

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