TheChek News Flow

The pace of activist campaigns has cooled against the challenging macroeconomic backdrop of 2023, but companies should remain vigilant to avoid ending up in an activist’s crosshairs.

That’s because market slumps and economic downturns can expose weaknesses at specific companies, handing activists blueprints to plot changes. In more-robust economic times, companies may have an easier time masking their troubles with surging cash flows. When the tide goes out, however, it’s harder to hide blemishes—especially if a company fails to keep up with peers.

Typically, activists seize upon companies that are underperforming in four areas: sales growth, valuation, net margin, and two-year stock performance, according to new analysis from Goldman Sachs, which examined component companies in the Russell 3000 index over a 17-year period. In a report, the bank identified 116 companies with market capitalizations of more than $5 billion that could attract activist attention, including retailer Best Buy BBY +1.35% (ticker: BBY), trading app Robinhood Markets HOOD +0.34% (HOOD), and industrial giant 3M MMM +0.84% (MMM).

There were 27 campaigns launched during the first quarter of this year, according to Goldman’s tally. That marks a 24% drop from the fourth quarter of 2022, and it also lags behind the pace of campaigns for all of last year, which totaled 148.

Despite fewer campaigns this year, activists have certainly been bold, targeting large-cap companies such as Walt Disney (DIS) and Salesforce (CRM). It’s all the more reason for companies to be wary.

S&P500 rises 8 per cent this year, but vast majority of gains were delivered by just seven stocks

A small number of tech companies are driving an ever-increasing share of the US stock market’s gains, prompting concerns among investors about the sustainability of the rally.

The S&P 500 has risen 8 per cent so far in 2023, but 80 per cent of the increase has been driven by just seven companies, according to Bloomberg data. Apple and Microsoft have led the way, contributing around 40 per cent of the index’s rise as they added more than $1.1tn in combined market capitalisation.

The trend has been growing for several months. However, the gulf between the small number of winners and the rest of the market widened over the past week as strong tech earnings contrasted with mixed results in other sectors and downbeat economic data.

Stuart Kaiser, head of equity trading strategy at Citi, said many investors were growing nervous about the fragility of the rally, but were reluctant to pull back and risk missing out on further gains.

“People are considering diversifying because the [tech] outperformance has been so wide, but we’re not seeing people pulling back yet”, he said.

Big tech has benefited from enthusiasm about generative artificial intelligence, along with a belief that the sector would be relatively insulated from an economic slowdown, and expectations that the Federal Reserve is approaching the end of its cycle of interest rate rises. Many long-only investment funds are also rebuilding their positions from a low base after selling huge amounts of tech stock last year.

Nvidia, which designs high-powered chips crucial to the AI boom, has been the third-biggest contributor to the S&P’s rise, followed by Facebook owner Meta, which has rebounded from a rough 2022 to double in value so far this year. Next was Google owner Alphabet — another large investor in AI — along with Amazon and Tesla.

The stocks have gained an average of 44 per cent so far this year, compared with a 2 per cent increase in the equal-weighted S&P 500.

Sentiment about the broader market has been dominated by concerns about the economic outlook. Companies in the benchmark index are on track to report their second consecutive quarter of earnings declines, and data released this week showed economic growth slowed dramatically in the first quarter, to an annualised rate of 1.1 per cent.

“We understand why risk assets have done better through the winter,” Sonja Laud, chief investment officer at Legal & General Investment Management, said in an interview. US inflation started to back down towards the end of last year, then as 2023 got under way, Europe dodged an energy crisis and China emerged from its zero-Covid lockdowns.

“That meant we had a far better start to the new year,” Laud said. “But there’s no evidence since the 1970s that a rate hike cycle, especially as aggressive as the one we have seen, won’t lead to a recession, a financial crisis, or both. Why would this be different?”

That has left LGIM shying away from risky assets in equities and credit, and leaning more towards government bonds. Laud said the firm had asked every one of its fund managers to scour their portfolios to look for weak links that might struggle if the current slowdown turns more severe.

The cautious stance is typical among large money managers. Citi’s Kaiser said: “You can earn so much yield keeping money in cash that the hurdle rate or bar to put money into equities is quite high”.

Markets have already started to lose some of their steam. In all of April, the S&P gained 1 per cent or more in a day only twice — a tally that has gradually shrunk from six days in January. The index added 1.5 per cent for the month, the second-worst month of the year so far.

With so much of the strength resting on a small number of companies, any bad news for the tech sector — such as the Fed deciding to keep rates high for longer than investors expect — could have a disproportionate impact.

Still, some are hopeful that the rest of the market will be able to start catching up with the winners, rather than the other way round.

“Once you have extreme readings like leadership in a few stocks, that’s usually signalling the fact that things are already quite bad . . . it’s a sign more often that the market is bottoming,” said Denise Chisholm, director of quantitative market strategy at Fidelity.

“I understand the behavioural bias of people intuitively waiting for the last shoe to drop, but the data doesn’t support it when you look at the history of equities.”

Services and construction still show expansion, indicating uneven recovery across post-Covid economy

China’s manufacturing activity contracted in April, official figures showed, as global demand for goods slowed and Communist party leaders warned that a post-Covid recovery in the world’s second-largest economy had yet to gain solid footing.

The National Bureau of Statistics’ purchasing managers’ index fell to 49.2 points compared with 51.9 in March, falling below analyst expectations of 51.4 in a Reuters poll.

China’s non-manufacturing purchasing managers’ index, which includes the services and construction sectors, was 56.4, down from 58.4 in March but still showing expansion since President Xi Jinping ended the country’s economy-constraining zero-Covid policy in December.

A reading above 50 indicates expansion compared with the previous month, while one below 50 means a contraction.

“This is a mixed PMI report and suggests that China’s post-Covid recovery has somewhat lost steam and calls for continued policy support,” said Zhou Hao, chief economist at Guotai Junan International, a Hong Kong-based brokerage.

In a sign of China’s economic recovery from last year, state media reported forecasts that about 240mn passenger trips would be made during this week’s five-day May Day holiday, higher than in 2019 before the pandemic.

But while consumer activity is rebounding from a low base, the rest of the economy has deeper challenges, with the property sector still limping after a government crackdown and export markets fading as advanced economies weaken.

In March, China’s PMI showed a similar picture, with growth in manufacturing dipping despite a recovery in exports, while other sectors showed a rapid rise in activity, indicating an uneven recovery.

“Economic growth has exceeded expectations . . . and China’s economy is off to a good start,” the Communist party’s politburo said in a meeting on Friday. But the “endogenous driving force” of the economy was “still weak and demand insufficient”, state media Xinhua reported the bureau as saying.

Zhao Qinghe, senior statistician at the NBS, said in a statement on Sunday that the manufacturing PMI’s contraction was “due to factors such as insufficient market demand and the high base formed by the rapid recovery of the manufacturing industry in the first quarter”.

Production expanded slightly, but sub-indices for new orders, raw material inventories and employment in the manufacturing sector all fell.

Goldman Sachs said in a note that the non-manufacturing index’s performance was “still solid but lower than market expectations, suggesting continued recovery in construction and services sectors but at a slower sequential pace”.

Part of the recovery in construction was driven by infrastructure, the NBS said. Beijing has used infrastructure to stimulate growth following the property sector’s collapse over the past two years.

The politburo signalled more support for economic recovery and called for targeted “proactive fiscal policy” and “prudent monetary policy”.

“The incomes of urban and rural residents should be increased through multiple channels . . . and the consumption of services in sectors such as culture and tourism should be boosted,” Xinhua reported the politburo as saying.

Nomura forecast that China’s export industries would remain under pressure due to “the ongoing global tech downturn, heightened global financial market turmoil and deteriorating US-China trade relations”.

“The export downturn will likely continue to hinder the recovery of employment and manufacturing investment,” it said in a report prior to the PMI data release.

SVB’s implosion highlights the destabilising impact of quantitative easing

The recent failure of Silicon Valley Bank combined two ingredients: excess deposits and losses on assets, even in securities such as Treasury bonds that are ordinarily considered “safe”.

SVB did not have adequate liquidity to tolerate a bank run and did not have adequate solvency to meet its liabilities. Emphatically, however, the failure did not occur because there was too little liquidity in the banking system as a whole. It occurred because there was too much.

At the end of 2022, the US banking system had $18tn in domestic deposits, including an estimated $10tn of deposits insured by the Federal Deposit Insurance Corporation. That meant there were $8tn of deposits that exceeded the FDIC insurance limit.

Those destabilising excess deposits are there because in more than a decade of “quantitative easing”, the Federal Reserve took $8tn of bonds out of the hands of the public and replaced them with bank reserves.

Conceptually, one can think of a customer deposit as being “backed” either by reserves that the bank holds with the Fed or by assets such as an IOU that the bank received in return for a loan it made.

By buying trillions of dollars of bonds under quantitative easing, the Fed also in effect pushed trillions of dollars of deposits into the banking system, backed by newly created reserves rather than bank loans. Yet despite the most aggressive monetary expansion in history, the growth rate of US commercial bank loans (business, consumer, real estate) averaged just 3.4 per cent annually between 2008 and 2022, easily the slowest growth rate in data since 1947.

In 1852, Walter Bagehot wrote: “John Bull can stand many things, but he cannot stand 2 per cent.” For more than a decade, quantitative easing stretched that thesis to extremes.

Once the Fed created $8tn in base money, it ensured that, in equilibrium, someone in the economy would have to hold it indirectly as bank deposits, indirectly in money market funds or directly as physical currency.

All of the increased reserves — and associated bank deposits — earned nothing. Someone had to hold them, and nobody wanted to. The moment any holder attempted to put the money “into” a security, the seller of that security took the money right back “out.” Long-term securities, including Treasury bonds, were driven to record valuations because yield-starved investors, banks and pension funds could not tolerate the perpetual zero-interest rate world created by central banks.

Having engineered a toxic combination of excess bank deposits and yield-seeking speculation, the Fed ensured that instability would follow.

As I wrote in the Financial Times in January 2022, by relentlessly depriving investors of risk-free return, the Fed has spawned an all-asset speculative bubble that may now leave investors with little but return-free risk.

Investment losses have emerged since early 2022, both because inflation pressures forced the Fed to normalise rates after 13 years of zero-rate financial repression and because extreme valuations are never sustained indefinitely. The Fed can no longer operate monetary policy without explicitly paying interest to banks on the liquidity it created.

Sudden banking strains in the US and Europe, the British pension crisis last year, equity market losses — all these are merely symptoms of an unwinding bubble. The Fed itself would technically be insolvent if it was to mark its assets to market value.

In response to the insolvency of SVB, the FDIC took the bank into receivership, wiping out the stockholders and unsecured bondholders. This was, and remains, the proper approach to bank insolvency. The largest bank failure in US history — the 2008 failure of Washington Mutual — is unmemorable because it was also resolved in this manner. The FDIC took receivership. Stockholders and unsecured creditors lost because they were supposed to lose in this situation. Depositors lost nothing.

While the decision by the FDIC to cover uninsured deposits remains controversial, enhanced deposit insurance, funded by higher fees, may become necessary for a period of time. It is not the fault of savers that the banking system is drowning in excess deposits.

Savers, in aggregate, are captive victims of the Fed’s dogmatic “ample reserves regime”. Until it winds down this misguided experiment, global policymakers will continue their scramble to create new special programs, acronyms and emergency facilities to manage the whack-a-mole world of complications it has produced.

Reconnecting

As the leaders and ministers of nine northern European countries meet in Belgium’s Ostend to talk wind power today, the UK and the Netherlands will announce a new electricity link as part of efforts to boost green energy, writes Laura Dubois.

Context: European countries want to accelerate the rollout of green energy following Russia’s full-scale invasion of Ukraine, and Moscow cutting off most of its gas supplies to Europe. At a previous wind power summit last year, four countries pledged to produce 65 gigawatt of offshore wind power by 2030 and 150 gigawatt by 2050.

The second edition of the summit will focus on how to increase wind power capacity, Belgian premier Alexander De Croo told journalists last week. “This is not a commitment summit. It’s an action summit,” De Croo said.

Part of that is the new interconnector. The undersea cable dubbed “Lion Link” is to connect the UK and the Netherlands to a Dutch wind farm from the early 2030s onwards and will carry 1.8 gigawatts of energy, according to statements by the two governments.

The planned investment for the connector is €1bn, a person familiar with the talks said.

“This new connection further boosts energy security and energy independence in Europe,” said Dutch energy minister Rob Jetten. It would supply electricity “enough to power 2mn households,” he added.

“We are bolstering our energy security and sending a strong signal to Putin’s Russia that the days of his dominance over global power markets are well and truly over,” said UK energy security secretary Grant Shapps.

The UK already has eight interconnectors with European countries, including the Netherlands, with six more approved by UK regulator Ofgem to be built over the next two years.

Aside from the Netherlands, Belgium and the UK, the summit will be attended by leaders and ministers from Ireland, Germany, Denmark, Luxembourg, France and Norway as well as the EU Commission.

As more countries are taking part than last year, the pledges will rise to 120 gigawatts in 2030 and a minimum of 300 gigawatts in 2050, according to a document seen by the FT.

Representatives from the offshore renewable industry, meanwhile, called for additional investments by governments and the EU to reach the targets.

“Our industry is not large enough today to deliver the nine governments’ commitments and meet the rising demand for renewable electricity and renewable hydrogen,” some 100 companies and organisations wrote in a joint declaration.