Biden industrial policy upends market orthodoxy
Plus Archegos melts down, OPEC+ ramps up, NFTs plunge, Rutte survives
Thank you for reading another edition of Contention! This one has seven minutes of synthetically leveraged dissident business news. We cover:
Biden industrial policy upends market orthodoxy
Archegos collapse spotlights capital rot
Rapid Round: OPEC+ increases output, NFT prices face trouble, Rutte wins despite vaccine mess
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Biden industrial policy upends market orthodoxy
Key economic sectors played hot potato with big news last week, as major moves in energy, finance, and manufacturing all netted out to an up week across the board for markets. The Dow gained 0.2%, the S&P 500 1.4% and the Nasdaq 2.6%.
Tying all these threads together: an epochal shift away from free market orthodoxy toward a state-led “industrial policy,” if only the die-hard capitalist crusaders will allow it.
Friday’s monthly employment report confirmed the current upward job market trend. Economists expected a surge of 650,000 new jobs in March; they got 916,000 instead -- a huge beat fueled in large part by government stimulus. March was the best month for jobs since the last recovery wave peaked in August. March also saw the ISM Manufacturing PMI hit 64.7, the highest level since 1983.
Treasury yields moved up in response to the warming economy, with 5-Year notes jumping from 0.9% to 0.98% on Friday alone.
This, however, was not the week’s biggest job market news. On Wednesday, U.S. President Joseph Biden announced his highly-anticipated $2.25 trillion infrastructure plan. The bill -- or likely bills, plural -- includes…
More than $900 billion in physical infrastructure spending, including transportation, schools, hospitals, and climate-related resiliency upgrades
More than $500 billion for energy, water, and digital infrastructure, including EV charging stations, replacing all the country’s lead pipes, and ensuring 100% high-speed broadband coverage
$580 billion for manufacturing, including $180 billion for research and development -- the largest non-defense expenditure ever for R&D
$400 billion for elderly and disabled care
The proposal amounts to a new industrial policy for the United States: a concerted, state-led effort to direct resources into developing specific industries. Such sweeping investments fell out of favor in the Reagan/Thatcher era, but markets seem ready to abandon the laissez faire strategies of the past -- the S&P 500 crossed 4,000 for the first time ever after the announcement.
Biden’s plan openly justifies itself in terms of “countering and containing China,” and observers have said it “copies” China’s state-led development model. The Biden administration’s position now seems to be “if you can’t beat them, join them,” and business is signing on in agreement.
But China’s plans have the benefit of a system focused on social stability, while Biden’s bill faces huge hurdles from the business interests in charge of his government. Industry groups and conservatives in Congress expressed immediate opposition to proposed tax hikes that would finance the bill, including increases in corporate and high-income individual tax rates and making wealthy individuals count capital gains as regular income.
Fears about these taxes squeezing corporate bottom lines clearly miss the point. According to a new report last week from conservative think tank American Compass, corporations in the 1970s reinvested most of their capital back in their businesses more than 80% of the time. By 2017, most were instead letting their capital stock depreciate to fund dividends and stock buybacks.
This change isn’t the fault of “greedy executives” -- the buybacks have to get approval from independent directors. It’s due to the same falling rate of profit we see everywhere else in this economy. Capital investment returns less to shareholders on a risk-adjusted basis than just giving them the cash outright -- companies have a fiduciary duty to pay out the profits.
Biden’s infrastructure bill could reverse this by pulling major capital investments and R&D off corporate bottom lines, freeing up investment in the long run. To the extent this gets financed by capital gains taxes and corporate cash flows that would have otherwise gone to shareholder payouts, the bill shifts resources from the finance economy into the “real” economy.
It is now up to politicians to wrap their heads around the idea that state-led development like this is only forbidden for the Global South -- including China -- but an urgent necessity for the United States. If they do, it could mean a new historic era in the world economy. If they don’t, it will likely be too late to try anything else.
Archegos collapse spotlights capital rot
Markets rumbled early last week with the reverberations of one of the most rapid losses of personal wealth in history -- the collapse of Archegos Capital, a $10 billion “family office” run by controversial investor Bill Hwang. Forced sales of “exceptionally large” blocks of stock amounted to a $30 billion liquidation that weighed on both the companies involved -- ViacomCBS lost 60% of its value in four days -- and the banks that were forced to move the money.
Wall Street largely recovered by week’s end, but the debacle puts a spotlight on rot at the heights of the financial system. The most important question: was Archegos an outlier, or a warning sign for things to come?
Archegos is a family office -- essentially a hedge fund for a small group of closely related individuals -- started by Hwang after a 2012 SEC criminal settlement for insider trading and stock manipulation. The fund amassed huge positions in several companies -- ViacomCBS, Discovery Inc., Chinese tutoring company GSX Techedu, Baidu, and others -- through complex stock derivatives called Total Return Swaps (TRS) and Contracts for Difference (CFD).
Their structures are basically the same: they are bets on the direction a stock price will move. An investor pays a “prime broker” -- typically a large investment bank -- a fee for setting up the contract, and the bank agrees to pay the investor whatever the stock gains over a specific period of time. If the stock loses money, the investor pays the bank that amount on top of the fees.
The bank hedges its obligations by buying the stock in question, so the asset shows up on the bank’s balance sheet while all of the gains go to the investor, minus the fees. Lax disclosure requirements for family offices and the fact that Hwang never owned the stock himself meant he could move markets with little to no disclosure about his activities.
Compounding the risk: these derivatives are inherently “leveraged” -- the prime brokers are essentially lending money to the investors by buying the stock for them to bet on the price. Hwang’s trades meant he was leveraging his capital 5-10x.
Hwang used this leverage to move markets with the very same short-squeeze and gamma-squeeze methods we’ve talked about before, sending ViacomCBS up 300% in a matter of months. The setup unraveled when ViacomCBS announced a $3 billion secondary stock offering, sending the price down on dilution fears. Hwang now owed the banks money, and they demanded collateral to make sure he paid -- a margin call.
Hwang had spread his trades across multiple banks to access more credit than any one of them would have extended him, which meant his margin calls mounted -- it may be the largest such call in history. Hwang refused to trim his positions to avoid default, triggering the sell off. Two of his banks -- Credit Suisse and Nomura -- now face “significant losses” and credit downgrades.
The episode points to two interconnected lessons. First, not a dime of Archegos’ capital helped any business buy machinery or facilities or hire a single worker. It amounted to the purest grade of speculation possible, another indicator of the misallocation of capital endemic to our low-return era.
Second, soaring margin debt -- money borrowed to buy stocks -- in the economy at large suggests that risky bets like Archegos’ could be extremely common. Margin debt increased by 50% since February 2020, driving the current bull market. But Archegos shows that the same leverage that accelerated the climb can accelerate the tumble with just a little push.
For now, Archegos seems to be just a faint echo of approaching footsteps marking the end of the no-cost capital era.
Rapid Round
OPEC+ output boosts won’t help frackers
The OPEC+ consortium of oil-producing nations announced Thursday that it will gradually raise crude output by nearly one million barrels per month through July. The move follows expectations for increased demand from a reopening United States, but is still reserved -- daily output will remain around 6.5 million barrels below the onset of the pandemic.
The shift follows an earlier decision to not relax production cuts which helped drive West Texas Intermediate (WTI) crude toward $70/barrel before settling around $61/barrel today. OPEC+ wants to avoid producing too much given the risks of another wave of COVID and Europe's slow vaccine rollout.
The decision’s big loser: U.S. shale production, which will continue to decline through at least 2022, according to Bloomberg. In 2021, the industry could shed another 485,000 barrels per day. The current price is enough to make drilling profitable, but producers took on massive debts on the expectation of continued high prices before the pandemic, leading to a wave of bankruptcies, consolidation, and stingy capital expenditures.
NFT bubble might be bursting
Daily trading volumes in non-fungible tokens (NFTs) -- blockchain-based speculative vehicles for claiming ownership of digital images -- cratered last month from a high of $19.3 million on March 11 to $5.3 million on March 30. Average prices for the tokens are down 70% from February. The total value of NFTs in circulation at NBA Top Shot, where traders exchange digital trading cards, fell by $760 million to $1.09 billion even as the exchange announced a $305 million funding round.
Digital artist Mike “Beeple” Winkelmann, who sold an NFT for $69.3 million last month, went so far as to admit that the market is a bubble. “I absolutely think it’s a bubble, to be quite honest. I go back to the analogy of the beginning of the internet. There was a bubble. And the bubble burst,” Winkelmann said. “But it didn’t wipe out the internet. And so the technology itself is strong enough where I think it’s going to outlive that.”
The sector has also become a magnet for fraud. Fake NFT "stores" and so-called "wash trading," in which investors simultaneously buy and sell the same asset to create the illusion of high demand have become endemic. Wash trading is illegal for regulated assets, but NFTs remain a wild west scenario for speculators.
Rutte survives despite vaccine debacle
Dutch Prime Minister Mark Rutte narrowly survived a no-confidence vote on Friday. His party, the right-wing People’s Party for Freedom and Democracy, emerged as the winner in March’s general election, but rival MPs accused Rutte of lying about efforts to discipline another MP during coalition negotiations.
Rutte is the ringleader of the European Union’s liberal right whose austere politics have led to the continent’s disastrous vaccine rollout, prompting a new wave of COVID infections. The Union put all of its vaccine eggs in the AstraZeneca jab basket, due to the shot’s lower cost compared to Pfizer and Moderna alternatives. AstraZeneca has faced extraordinary side effect issues, as well as production problems.
The need for vaccines is causing some European countries to look to Russia and China for supplies. Slovakia, Croatia, Serbia, and Hungary have sought deals to acquire Russia’s Sputnik V vaccine, with Hungary and Serbia also cutting deals with China for its Sinopharm shot. Serbia’s partnerships with the two countries has given it one of Europe’s highest vaccination rates.
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