The Thrill is Gone



As the Federal Reserve starts exercising some atrophied muscles, traders will have to relearn their craft, too. The U.S. central bank is getting used to the idea of lifting rates above zero for the first time in seven years. That will reinvigorate some old-school market gauges. People used to watch fed funds futures, Eurodollar derivatives and a clutch of traded measures of inflation like hawks (or doves). These indicators are due fresh attention – even if their meaning has morphed.

The Fed guessing game will intensify as traders make bets on what Chair Janet Yellen and her colleagues will do at each of 2016’s eight monetary policy meetings. Fed funds futures, nowadays helpfully analyzed on the CME’s FedWatch web pages, provide a market-implied trajectory for overnight interest rates in the near term.

There are wrinkles in the post-financial crisis world, though. For instance, if the Fed sticks to a range for the fed funds rate rather than a specific level – the official target for seven years has been between zero and 0.25 percent – it makes the meaning of futures prices fuzzier because calculating implied probabilities of Fed moves requires assumptions about exact target rates.


More broadly, financial markets have changed since before the financial crisis. Banks must hold more capital and they face other regulatory constraints, while central bank balance sheets have expanded dramatically – the Fed’s has swollen to $4.5 trillion from under $1 trillion in early 2008.

Such effects could create new distortions relating to inventory levels, market liquidity and trading norms. That’s even more significant for other tools like overnight indexed swap (OIS) rates and Eurodollar futures. Using Eurodollar futures, for instance, to glean the market’s view of the longer-term path of Fed policy involves estimating the so-called basis, or gap, between Libor and fed funds rates. Pre-crisis rules of thumb may prove way off.

Fed-watchers will also eventually need to track inflation again. Statistical estimates, even those aiming to exclude energy costs, could be suppressed by recent low oil and commodity prices. Financial measures, like breakeven rates on U.S. Treasury inflation-protected securities or TIPS, may suffer from the same post-crisis market distortions.

Traditional navigational instruments may still point in the right directions, but traders feeling out how they now relate to each other could cause a few market fender benders in the year to come.

Published December 2015

(Image: REUTERS/Jonathan Ernst)



Pfizer’s $160 billion takeover of Allergan marked a few milestones in the mergers and acquisitions trade. It was the top deal of the year, exceeding Anheuser-Busch InBev’s purchase of SABMiller, and by some measures is the second biggest in history. The all-stock transaction also vaulted the total value of corporate dealmaking in 2015 beyond the record set in 2007, just before the financial crisis shuddered things to a halt.

The pharmaceuticals union also printed another, more dubious superlative as one of the largest deals ever predicated on exploiting global tax loopholes. Without the ability for Pfizer, the larger of the two companies, to back its way into Allergan’s lower-tax Irish domicile, the maker of Viagra, Lyrica and other sweet-sounding compounds would have incinerated some $17 billion of shareholder treasure.

That this high-water mark of M&A is justified by its tax workaround would be sign enough that the two-year boom of extraordinary corporate promiscuity is reaching its logical conclusion. Other, perhaps less perceptible, warning bells are clanging, too, which suggest companies are increasingly pursuing financial engineering to fix troubled core businesses, a trend that in previous booms has ended poorly for investors.

The desire of companies to band together and reduce overlapping costs won’t diminish any time soon, particularly as the prospects for global economic growth look mediocre at best. Thanks to Pfizer’s combination with Allergan, the value of worldwide announced M&A reached $4.2 trillion in 2015, according to data compiled by Thomson Reuters, up from around $3.5 trillion in 2014, and surpassing the record achieved eight years earlier.

Pfizer isn’t the first healthcare company to take advantage of a so-called inversion, wherein it merges with a rival based outside the United States to reduce the overall tax burden in ways that enhance the bottom line. Pfizer’s is, however, far and away the biggest on record: The drugmaker led by Ian Read is expected to save $1.7 billion in payments to the tax man by 2018, according to an analysis of the deal by my colleague Rob Cyran.

What’s more, Pfizer’s inversion is larger than the previous 10 such deals in the industry combined. That includes the $66 billion merger with Actavis that created Allergan earlier in 2015. Together, those transactions add up to around $140 billion in value, Thomson Reuters data show.

At least Pfizer can justify the expenditure on Allergan using arithmetic, however illusory the savings may turn out to be if the U.S. government modifies its tax code in the next couple of years. A handful of smaller takeovers, unveiled in the days leading to Pfizer’s big one, are harder to fathom, and point to an anecdotal spate of distracted dealmaking that is often emblematic of a peak in the M&A business.

Take the case of Urban Outfitters, the $2.9 billion apparel retailer, buying a pizza chain. Its acquisition of The Vetri Family group of restaurants is guided by the notion that Urban Outfitters, which also operates the Anthropologie brand, can increase foot traffic to its stores by selling customers food and beverages alongside scarves and underpants. According to Urban Outfitters Chief Executive Richard Hayne: “Spending on casual dining is expanding rapidly, and thus, we believe there is tremendous opportunity to expand the Pizzeria Vetri concept.”

While consumers may be spending more on mozzarella than denim, it’s a clear instance of strategic shift for a fashion company in trouble. Urban Outfitters shares have lost more than a third of their value this year. Its third-quarter sales, released shortly after the pizza purchase, came in shy of what analysts had been expecting and its same-store sales barely budged from the year before.

Pandora, the $3 billion music-streaming pioneer, is another example of a company reverting to M&A to stray beyond its challenged main operations. Like Urban Outfitters, the market has not been kind to Pandora shareholders, who are down some 20 percent on their investment year to date. It’s not usually a show of confidence, however, that the company has been buying assets in so-called “adjacent” businesses to its own.

On the same day Urban Outfitters got into the pizza game, Pandora agreed to pay $75 million for some technology and intellectual property assets of Rdio, a rival service of sorts that filed for bankruptcy. The deal, coming after a profit-warning shocker and an earlier move into the “adjacency” of live music ticket sales with the $450 million purchase of Ticketfly, further unnerved shareholders.

Pandora’s boss Brian McAndrews described the deals as “defining the next chapter of Pandora’s growth story.” The implication, however, is that Pandora’s current chapter is over. ConAgra, meanwhile, has already started and ended a new phase within this very deal cycle. It disastrously tried to marry its branded consumer goods like Chef Boyardee with the white-label Ralcorp. Some two years after paying $5.1 billion for the business, it agreed in November to offload it to TreeHouse Foods for $2.7 billion.

Earlier eras experienced similar adjacency calamities. Nokia got into mapping software with Navteq, paying $8.1 billion in 2007 and offloading it in 2015 for $5 billion less. In a previous boom, Germany’s Daimler spectacularly failed to combine its luxury car know-how with the mass-market Chrysler. And the AOL-Time Warner combo of that vintage still stands as the mother of all mission drifts.

As such deals increasingly characterize the latest M&A bacchanal – along with those where clever financial structures overwhelm strategic logic – it presents strong evidence of a last hurrah.

Published December 2015

(Image: REUTERS/Lisi Niesner)



A fall in tech valuations may send U.S. and Chinese unicorns running in different directions. Several private Silicon Valley firms worth $1 billion or more have taken valuation hits once they are in the public eye. The same may be happening to one-horned beasts in the People’s Republic, only in private.

Take Jack Dorsey’s U.S. online payments outfit, Square. The shares popped enthusiastically on the company’s stock market debut in November, but its market capitalization remains about a third below the $6 billion price tag implied by an earlier private funding round. Some unicorns that have yet to go public are already feeling the chill. Fidelity Investments, a prominent investor in late-stage private financings, recently marked down its holding in Snapchat by 25 percent from a headline valuation of $16 billion in May.

graphic-US Chinese unicorns will bolt in opposite ways

(Source: CB insights. REUTERS/Robyn Mak)

Super-unicorns such as Uber and Airbnb, valued at roughly $50 billion and $25 billion, respectively, on the strength of relatively small private fundraising exercises, can still tap Fidelity, T. Rowe Price and others for funds. These investors may be more cautious than they were, but it’s a more appealing option than an initial public offering with the risk of a very public drop in valuation.

Of the four unicorns that have listed in 2015 only one, Shopify, floated at a mark higher than its last private price, according to data compiled by TechCrunch. Of the 14 that have gone public since 2011, half have traded down since their IPOs. Meanwhile the number of U.S. private-market unicorns continues to rise.

China’s members of the club face skepticism, too, but in pre-IPO markets. Private equity and venture capital appetites have cooled since the stock market crashed in June, with investments for October hitting $2 billion – just a third of the previous month’s total, according to Zero2IPO research, and down 30 percent year-on-year. The slowdown probably helped prompt October’s $15 billion merger deal between two group-discount website unicorns, Meituan and Dianping. And U.S.-style late-stage funding from established institutions is hard to come by.

That means many of China’s startups may not have the option to stay private. They may not want to anyway, because public valuations are still high. The Nasdaq-style ChiNext board in Shenzhen trades at a whopping 80 times earnings and is up 80 percent this year. Regulators recently lifted an IPO ban, too.

Funding scares will probably cause U.S. unicorns to shy away from IPOs, but the Chinese species may run towards them.

Published December 2015

(Image:REUTERS/Jim Urquhart)



Oil-rich Gulf sheikhdoms are being forced to raid their sovereign wealth funds to shore up their budgets. With U.S. crude oil prices falling below $40 per barrel in December, they have no choice but to reach into these rainy-day savings. For now, they can hold on to some of their trophy assets, like strategic investments in Volkswagen or Barclays. But if crude prices keep tumbling, a fire sale will be hard to avoid.

During the most recent energy boom, the six members of the Gulf Cooperation Council (GCC) – including Saudi Arabia, Qatar and Kuwait – amassed sovereign funds worth more than $2.3 trillion. These assets have traditionally comprised a mix of debt and other securities, in addition to influential stakes in some of the world’s biggest companies such as Glencore, VW and Barclays.

Large chunks of this cash are now being repatriated back to the region to finance widening budget deficits, which this year are expected to be in the region of 13 percent of GDP in the GCC. Should oil prices average $56 per barrel next year, then GCC states would need to liquidate some $208 billion of their overseas assets, or just below 10 percent of their sovereign fund holdings, based on a Breakingviews analysis of their fiscal break-even costs.

But if oil prices fall to $20 a barrel, as Goldman Sachs has warned, the GCC states may have to sell $494 billion worth of booty to make up the budgetary shortfalls based on forecast fiscal costs for their oil production in 2016. This is provided they maintain the lavish rates of public spending that the region’s populations have become accustomed to.

At that rate of divestment these sheikhdoms – which pump about a fifth of the world’s oil – would almost drain their funds entirely by 2020. The Saudi Arabian Monetary Agency, which also acts as the country’s central bank, has already started to sell down some of its foreign assets, while money managers are reporting growing redemptions from other funds in the region.

Gulf rulers have so far resisted any temptation to jettison their most treasured assets, which in many cases have granted them board seats atop some of the world’s leading companies. If oil keeps falling, even these investment jewels will come up for grabs.

Published December 2015

(Image:REUTERS/Esam Omran al-Fetori)



Caterpillar, the $39 billion maker of machines that dig mines and lay asphalt, is ready for a metamorphosis. Daft deals hatched at the height of the commodities and Chinese investment booms have trashed the company’s stock and damaged the credibility of its management. An investor seeking change, potentially a breakup of the conglomerate, could play well on Wall Street, if not in Peoria.

The company led by Chief Executive Doug Oberhelman emits the kind of pheromones that attract pushy investors like Nelson Peltz, whose Trian recently bought a stake in General Electric. Caterpillar has no single large shareholder, making it easy for an activist to creep into the capital structure and make a stink.

Caterpillar’s executive team is also vulnerable. Five years ago, the company, based in Peoria, Illinois, struck its biggest acquisition since founder Benjamin Holt rolled out the first of his steam tractors capable of crawling, caterpillar-like, over soggy farmland. Just after taking charge of the company that has now employed him for 40 years, Oberhelman paid $8.6 billion for Bucyrus, which makes equipment used to mine raw materials like iron ore.

The deal is fast becoming a case study in bad timing. A global commodities glut slammed Caterpillar’s new customer base, and shows no sign of relenting. Anglo American, for instance, initiated a restructuring that will cull 85,000 employees. Shares of the seven big London-listed miners have halved in value this year.

Caterpillar’s own stock has shed a fifth of its value since acquiring Bucyrus. The S&P 500 Index, by comparison, has gained 72 percent over the same span. And Bucyrus’ main rival, Joy Global, has lost 84 percent of its market value, implying that Caterpillar has been dragged down by infesting its other world-class businesses with dangerous commodities.

Though Caterpillar is best known for its earth-moving machinery, Credit Suisse notes that the company derives 39 percent of sales and 53 percent of profit from its energy and transportation business. That division manufactures turbines and other apparatus that compete with GE, whose shares have nearly doubled since Caterpillar bought Bucyrus.

Add it all up and Caterpillar may soon find itself exposed to a new investor eager to crack open the chrysalis in search of a butterfly.

Published December 2015

(Image:REUTERS/Hereward Holland)



The least bad way to help Europe may be to dismantle Schengen. The 26-country free border zone is struggling to cope with refugees and security risks. Abolishing Schengen would be expensive, wouldn’t solve migration problems and would look like a U-turn on core European Union principles. Yet it might dampen the populism that threatens Europe’s economic integration.

Like the euro, the Schengen zone that enables 400 million European citizens to travel without passports has proven incapable of coping with real-world pressures. Schengen made it easier for citizens to travel and trade. But it lacked a proper system for protecting external borders in Greece, Italy or Eastern Europe, or a system for rehousing asylum seekers. Its loose security arrangements look naïve in an era of homeland extremist attacks, like Paris on Nov. 13.

And just like the euro, the ideal solution would be to have more Schengen, not less. That would mean policing external borders properly, sharing genuine asylum seekers equitably. It requires trust, cooperation and time. Instead, the region is going backwards: de facto, temporary borders are being erected, and there’s talk of ejecting countries that can’t observe Schengen rules.

Abolishing or limiting Schengen would be damaging, but it is wrong to characterise it as a disaster for the European project. It would not impair European citizens’ rights to work or trade, nor stop them from holidaying. It would create costs to monitor borders and transport goods. The Dutch Association for Transport and Logistics puts the cost for Dutch hauliers at 600 million euros. Given that Dutch truckers make up about 7 percent of transports across the region, the cost could be just shy of 9 billion euros.

Some form of rowback on Schengen may become inevitable if the migration crisis can’t be tackled. Yet it would have some benefits. Chief among them is addressing the populist rhetoric in France, the UK and Eastern Europe that sees any migration as a threat. British anti-Europeans, already outside of Schengen, may welcome signs that the region can police itself, and thereafter be more open to the other benefits of the union. Sure, showing one’s passport when crossing the EU is a drag, but worth it if the alternative is having no EU to cross in the first place.

Published December 2015

(Image:REUTERS/Yannis Behrakis)



Central bankers were the next best thing to superheroes during the financial and euro zone crises. But after rescuing banks, markets and even countries, they have finally encountered their kryptonite: consumer prices.

Inflation has refused to materialise despite the most unorthodox efforts of the most influential rate-setters. U.S. Federal Reserve Chair Janet Yellen, European Central Bank President Mario Draghi and others in the Group of Seven industrial nations slashed policy rates to record lows and together bought financial assets worth more than $10 trillion – roughly equivalent to the combined currency reserves of all the world’s central banks.

Economic activity has picked up but consumer prices are proving recalcitrant. G7 inflation averaged less than 0.2 percent in the first 10 months of 2015, OECD data shows.

Worse still, central bankers’ power to bend markets to their will is waning, reducing their ability to weaken currencies and thus make imports more expensive. Draghi’s old nickname of Super Mario looked less apt after his Dec. 3 policy easing had the perverse effect of pushing the euro and bond yields up sharply rather than down.

Time to deploy other policy levers. First, governments could start gently reversing half a decade of fiscal policy tightening. The mostly rich OECD countries will in 2015 run a structural deficit – that is, one which strips out the effect of economic swings – of 2.5 percent of potential GDP, the lowest in a decade and a half, the international organisation says. Voters’ austerity fatigue and circumstances such as Europe’s migrant crisis and security concerns all suggest some slippage ahead.

Second, pay could do with rising faster. In 2014, real average wages in the OECD rose 0.2 percent, less than a fifth of the average annual increase seen between 2000 and 2007. Politicians are already thinking along these lines. Japanese Prime Minister Shinzo Abe plans to raise the national minimum wage by 3 percent each year from the next fiscal year, and the UK wage floor is due to rise more rapidly in the coming years.

Even fiscal and wage measures might fail. Further falls in oil prices or a Chinese currency depreciation could counteract their inflationary impact. But that shouldn’t stop politicians from using what powers they have – especially now central bankers are proving helpless.

Published December 2015

(Image:REUTERS/Ralph Orlowski)



Argentina and Elliott Management will finally give peace a chance in 2016. There may never be a better time for Latin America’s third-largest economy and Paul Singer’s hedge fund to end a 14-year standoff over defaulted bonds. New President Mauricio Macri needs access to global credit markets to implement his economic plan, and another defiant Peronist like predecessor Cristina Fernandez could take over if he fails.

An Elliott affiliate has sought repayment of the bonds since Argentina’s 2001 default. It and other investors refused to swap them for discounted debt in 2005 and 2010, and in 2012 won a court order saying creditors that accepted the exchange could not be paid first. Argentina protested mightily, even appealing to the U.S. Supreme Court, but to no avail.

Obstinance has come at a high price. The nation faces double-digit inflation, dwindling foreign reserves and a gaping fiscal deficit. The economy will grow just 0.4 percent in 2015 and shrink 0.7 percent in 2016, the International Monetary Fund forecast in October. A settlement with the holdouts, owed up to $15 billion, could reopen sources of foreign capital and help reboot growth.

A resolution is far less urgent for Elliott, considering its total sovereign debt holdings are a tiny fraction of its more than $27 billion of assets under management. Yet the expense of battling for repayment is mounting, and the firm is eager for a return on its investment.

Fernandez called the holdout bondholders “vultures.” But just before his Dec. 10 inauguration, Macri sent an emissary to meet the court-appointed mediator in the dispute. Though the shape of any deal is unclear, it would surely exceed the less than 30 cents on the dollar offered in the 2010 exchange.

The trick for Macri will be getting any deal through a left-leaning Congress, where he might be able to bargain with, among others, pragmatic Peronists not loyal to Fernandez. If the new president can’t fix the economy, his administration could quickly founder. A far less amenable counterparty might then succeed him – maybe even Fernandez herself, who could try to return in 2019. That alone should persuade Elliott and Argentina that further stalemate is pointless.

Published December 2015

(Image:REUTERS/Martin Acosta)



Quarterly capitalism has become a four-letter word. From BlackRock boss Larry Fink to American Democratic presidential contender Hillary Clinton, critics of the overweening desire to hit the numbers every three months, common among both investors and managers of publicly traded companies, see a fundamental flaw in today’s system. But words are cheap. For the system to change, significant players have to make the first move. That may happen in the year ahead.

Corporate executives have long railed against the treadmill of reporting their guts out every three months. They say it’s a waste of time, costs money, and is a distraction from the more important tasks of setting strategy and running a business. They moan that it creates unnecessary and unhelpful swings in stock prices and debt funding costs and, most damaging of all, hinders longer-term planning.

Defenders of the practice do not say they need news flow to trade, or that trading is fun and profitable. They talk about transparency. Stock-market investors who have regular glimpses into corporate finances are better placed to judge the progress of strategy, assess the efficacy of management and gauge product cycles. The ultimate investors – widows, retirees, teachers and billionaires – gain from the knowledge.

This logic has led to mandatory quarterly reports for companies with securities regulated by the U.S. Securities and Exchange Commission. For the last three decades, the instinct to tell more, and more frequently, has gone global.

Germany’s Deutsche Boerse requires companies to provide detailed statements every quarter. Even where such regularity of reporting is no longer required – as in the United Kingdom since 2014 – it is still the convention.

But the trend may be reversing. This past summer, UK insurer Legal & General’s $1 trillion investment-management arm nudged the debate forward when it wrote a letter to the top 350 companies on the London Stock Exchange urging them to consider dropping quarterly reporting.

“Reducing the time spent on reporting that adds little to the business,” Legal & General Investment Management Chief Executive Mark Zinkula wrote, “can lead to more articulation of business strategies, market dynamics and innovation drivers, which are linked to key metrics that drive business performance and long-term shareholder value.”

While lots of stewards of other people’s money agree in principle, in practice many still worry that any company that only gives its investors a look into the sausage factory every six months will be stigmatized in the markets. Classically, this would manifest itself as a valuation discount to peers. It’s worth noting that Legal & General itself still provides interim management statements every quarter.

The world’s largest public fund managers and insurers could help change habits by firmly stepping off the quarterly treadmill, at least where the law currently allows. After all, shareholders set the theoretical transparency discount by deciding what shares to purchase and at what price. Ultimately, these human beings determine valuations.

If the custodians of trillions of dollars of assets decide what’s good for the goose (ending quarterly reporting by the parent) is also good for the gander (the portfolio managers they employ) then other companies in other industries can follow suit. Ten of the largest listed investment managers – including BlackRock, Allianz, State Street and Bank of New York – oversee some $10 trillion of wealth.

There will be resistance. Not every investor buys the argument that quarterly reporting is a bad thing. It may help avoid problems earlier, before they fester – giving shareholders time to get out or press CEOs to fix matters more rapidly. And businesses in technology, retailing, consumer goods and media probably move too swiftly for six-month updates to be sufficient.

The quarterly-financial-industrial complex won’t like a big shift, either. Stock exchanges like Deutsche Boerse and Nasdaq benefit from companies reporting twice as often in a given year, as it bolsters trading volumes and fills their faster-growing “market data” business pipelines.

More frequent corporate dispatches are arguably better for the news and information business, too, including Breakingviews parent Thomson Reuters. It even benefits Warren Buffett, who has often lamented short-termism in the investing world. Berkshire Hathaway owns Business Wire, which would see its volume of earnings reports cut if the world moved to report twice a year.

It will take a brave and big investment manager to get beyond these entrenched interests and sustained effort will be needed to modify rules requiring disclosure four times a year. But if the signals from fund managers with the most at stake are genuine, expect their corporate parents to lead the way in the not so distant future.

Published November 2015

(Image:REUTERS/Lisi Niesner )



More than just a nice desk in the Oval Office awaits the next U.S. president. Whoever wins the campaign will probably contend with an economic recession, no matter what the Federal Reserve does with interest rates. The great downturn ended six years ago, longer than it traditionally takes for another slowdown to hit. Given the sluggish recovery, another peak could be years off. But unless modern records are shattered, today’s White House contenders will need to brace for a crisis.

Since the Great Depression, the average period between the end of one American recession and the start of another has been about five years. By that metric, the economy is currently operating on borrowed time. It has been more than a year longer than that average since the slowdown that accompanied the global financial crisis ended in June 2009.

Of course, this time around it might just take a little more time than usual to rebound. The United States enjoyed 10 recession-free years from early 1991 through early 2001. That’s the longest uninterrupted period of prosperity in 150 years of record-keeping. That means unless this is another historically unprecedented moment, another recession will arrive by June

True, most economists don’t see an imminent slowdown. They expect the Fed to eventually begin to raise interest rates in response to the economy’s strength and its ability to weather tighter monetary policy. As Goldman Sachs explained in a research note, the unusually slow recovery implies a longer-than-usual cycle. The bank does not forecast a recession for 2016, the last full year that Barack Obama will occupy the White House.

If correct, that makes any slowdown a problem for, take your pick: President Donald Trump, Carly Fiorina, Bernie Sanders, Hillary Clinton, etc. If it starts early enough in the 45th president’s first term, the commander in chief might be able to place the blame at Obama’s doorstep. But every time since World War Two that an American president faced a recession that began after his first year, he failed to win re-election.

Presidents don’t deserve all the blame for the unavoidable cycles of developed economies. That doesn’t stop voters from thinking otherwise. Moreover, if the next boss happens to be Jeb Bush, a recession on his watch would mark the fourth in a row to have begun under a member of his immediate family. He and his rivals need to brace for the inevitable.

Published September 2015

(Image: REUTERS/Larry Downing)