Business wins while Texas freezes

Plus interest rates loom, Palantir reports, Congress hears about GameStop

Welcome to another edition of Contention! This week we have just about seven minutes of record freezing dissident business news. We cover:

  1. Markets eye interest rate rise

  2. Business wins while Texas freezes

  3. Rapid Round: Palantir stumbles, Washington’s Big Squeeze hearing 

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Markets eye interest rate rise

Markets ended the holiday-shortened week with the Dow up 0.1%, the S&P 500 down 0.7% and the Nasdaq losing 1.6%. Employment market struggles deepened again, but rising interest rates weighed on markets most of all. A disrupted economy and deep misunderstandings about money are fueling confusion and concern.

Rates on the benchmark 10-year U.S. Treasury bond hit 1.36% this week, a more than 50% increase year-to-date. Nothing in particular seems to have spurred the move, but rates typically reflect growth and inflation expectations. 

The differences in stock index performance last week show the ways the move affects equities:

  • The Dow went up because it includes a disproportionate number of financial companies benefitting from a steepening yield curve. Banks charge debtors at higher long-term rates and pay depositors at lower short-term rates, pocketing the difference.

  • The Nasdaq dropped because it is full of tech stocks, which investors buy to cash in on long-term earnings from innovation. Higher interest rates mean that future money is worth less today

Rates rose enough to cross an important historic threshold: tech stocks typically yield at least 2.5% more than 10-year bonds, but last week they fell below that premium. Tech companies have -- until now -- been less likely to collapse than the U.S. government, so investors expect that extra payment for risk. If they can’t get it, the smart move is to sell stocks and buy bonds instead. Analysts now think stocks might be irrationally overpriced

Most stocks are owned by the wealthy, so a market correction shouldn’t mean much for working families as long as the economy is still growing. But if the rates reflect inflation expectations due to an overstocked supply of money, rising prices could really hurt pocketbooks.  

The good news: that’s not how money actually works, despite what orthodox economists believe.

These experts believe in a simple equation: the money supply multiplied by the velocity of money -- how many times the same dollar gets spent in successive transactions -- is equal to the price of all goods and services sold on the market. Given a specific level of economic activity -- money velocity and production output -- an increase in the money supply causes an increase in prices.

But if that’s the case, why has a 1,000% increase in the Federal Reserve’s balance sheet over 13 years had nearly zero impact on inflation? Why have decades of quantitative easing in Japan barely budged its persistently deflating currency

Because orthodox economics gets the equation backwards. Producing and selling commodities at prices commensurate to their intrinsic value determines the money supply. When production ramps up, banks create money by increasing their lending, and money gets pulled out of various savings instruments. Bonds are one of them, and the resulting sell off raises interest rates. When production drops off, governments can try printing money, but the funds just get socked away for later -- production is primary. 

In recent downturns, central banks “printed” money in ways that also suppressed interest rates. This market intervention made risk artificially cheap, pulling hoarded liquidity into stock markets, bidding up prices. But outside of stocks, increasing the money supply had no impact on price inflation. The money went into the same pockets that were already full of it.

Rising interest rates are now changing those calculations, hence market trepidation. In fact, it might be this fear that’s driving the rate increase in the first place -- a variety of signals suggest that investors want a risk premium as no one knows where the pandemic and recovery are headed right now. 

This is a wise move: turns out even the people in charge have no idea what they are really doing. 

Business wins while Texas freezes

Upwards of four million Texans were without power for several days last week and 14 million still have no access to safe drinking water as a “polar vortex” brought record low temperatures and snowfall to the state. The same weather affected dozens of other states, but in Texas it met unique infrastructure, business conditions, and history all adding up to a catastrophic failure of basic services.

A deep mismatch between supply and demand for utility energy precipitated the disaster. Exceptional cold meant cranked-up heaters and record winter power demand. 

Supply-wise, Texas relies on natural gas for roughly half of its electric generation, with power plants drawing much of their supply directly from drillers in the state. As gas lines froze and power plant equipment seized up, the Texas electrical grid -- separate from the two covering the rest of the United States -- neared collapse. The Electric Reliability Council of Texas (ERCOT), the state’s grid regulator, ordered emergency blackouts, which left millions dark and cold for days. 

Texas’ utility regulators -- the Public Utility Commission (PUC), which oversees ERCOT -- have competing priorities: ensuring reliable electricity at non-predatory prices, and maximizing free market principles in regulating generation. All energy in Texas is bought and sold on the open market, but to prevent politically-risky price spikes, the PUC caps wholesale energy prices.

The storm wreaked havoc on this system. First, blackouts meant a sudden drop in demand and wholesale delivery prices, forcing the PUC to issue an emergency rule on Monday requiring generators to produce and sell power. Otherwise their business models might have rewarded waiting around for demand to rise, further extending blackouts. 

At the same time generator output prices plunged, their fuel input prices soared. Natural gas at 100x the normal rate meant that price caps based on gas prices skyrocketed. The PUC issued an emergency rule to lower the cap, but the damage was already done: utility customers are now getting five-figure electricity bills covering a period when their electricity was shut off. 

The squeeze is likely too much for many smaller power companies. The PUC has already anticipated these bankruptcies by issuing an emergency authorization on Friday for NRG Energy and Vistra Corp to scoop up customers shed by the failures. The two companies currently control 70% of the Texas utility market, and new consolidation puts consumers at risk for price hikes. 

Texas’ selective faith in free markets played a bigger picture role in the crisis as well. The state experienced a similar, much less severe supply crunch following winter storms in 2011, prompting regulators to recommend winterization for Texas power plants. Texas policymakers left this decision up to markets: the incentive of big demand pricing was supposed to spur investment in protecting their supply. 

But businesses see winterization costs on the balance sheet, and backward-facing models say that future record-cold price boons are remote. Holding off on capital outlays makes good business sense until climate change upends their predictions, catching them out in the cold -- literally.

So Texas regulators failed at both of their objectives: they needed emergency state planning to cover market failures, and consumers got screwed. Texas Gov. Greg Abbott is now calling for mandatory winterization of power plants, but the PUC is unlikely to do much to upset the companies that created these problems: 

Natural gas producers hit the “jackpot” last week and cascading shortages mean surging oil prices worldwide, benefitting the state’s largest industry. The bottom line: the people responsible for the mess in Texas may not see a problem that needs fixing at all. 

Rapid Round

Palantir stock dips despite big ambitions

Palantir's stock price plummeted more than 30% last week before a rebound Friday as the big data analytics firm reported a fourth quarter loss. Palantir’s post-IPO lockup period is also expiring, allowing early investors to liquidate their shares. Revenue totaled $322 million, up 40% from a year ago -- a sign of Palantir’s growing reach beyond government customers to commercial business.

That's an opportunity for other traders to buy Palantir stock at a bargain, spurring retail punters at r/WallStreetBets to help fuel a Friday melt up as Ark Invest's Cathie Wood bought 6.8 million shares, a bullish call after spending 2020 betting heavily on Tesla. Palantir was previously a Reddit cash cow in January when prices rose to $39/share.

Palantir’s management, including board chair Peter Thiel -- a billionaire with ties to the alt right -- used novel governance structures to ensure that the company remained under their close control even after going public last year. It believes its mission is to make “the West the strongest it has ever been.” The company has collaborated closely with security agencies and enhanced police surveillance powers

Will 2021 be Palantir's big year? The firm expects revenue growth of 30% this year and to reach $4 billion in revenue in 2025. In recent weeks, Palantir also won customers IBM and mining giant Rio Tinto. CEO Alex Karp is trying to widen the company’s gaze to Europe, setting up the CIA-connected company’s European headquarters in the Swiss Alps

The GME gang goes to Washington

The U.S. House Financial Services Committee held hearings on Thursday to investigate last month’s GameStop-fueled short squeeze and trading platform Robinhood’s role in the crisis. Robinhood chief executive Vlad Tenev, Citadel Securities CEO Ken Griffin, Melvin Capital CIO Gabe Plotkin, Reddit CEO Steve Huffman, and r/WallStreetBets hero Keith Gill a.k.a. DeepFuckingValue all testfied. 

The legislators asked about Robinhood’s total assets and whether the firm had covered its risks, given that the brokerage halted trading when GameStop’s price spiked. Members also had questions about how Robinhood’s game-like interface dazzles inexperienced traders with virtual confetti when they buy, like slot machines in a casino. 

“You are encouraging your customers to tap 1,000 times a day,” Rep. Ritchie Torres (D-NY) said. The platform already settled a case with the SEC over these allegations in December, changing its interface afterwards. 

Robinhood’s role in the affair overshadowed the parts played by Citadel and Melvin, despite the latter two making and losing billions off the episode. During the short squeeze, Citadel -- which pays Robinhood for order flows, profiting from trading volatility -- invested in Melvin, which had shorted GameStop and lost 50% of its investment. Citadel’s role on both sides of the chaos has raised concerns about market manipulation. Plotkin insisted that Citadel’s investments were no “bailout.”

Meanwhile, Melvin says it will pay closer attention to what’s happening on Reddit to head off being blindsided again by retail traders. They’re not the only ones. Wall Street firms are already rolling out tools to monitor the most-mentioned stocks on WallStreetBets and comparing the frequency against statistics on their short positions. Lawmakers had no questions about these developments. 


Disclaimer

Our only investment advice: Enjoy the black metal weather.

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