Closing Market SummaryThe stock market ended Wednesday on a weak note with the major averages finishing near yesterday's lows. The S&P 500 lost 0.8% while the Russell 2000 (-0.5%) finished a bit ahead despite lagging in morning trade.
Early action saw a continuation of yesterday's selling with some recent top performers fueling the retreat. The financials sector (-1.7%) underperformed throughout the day after rallying off a 13-month low at the end of May. Today, the sector was pressured by comments from JPMorgan Chase (JPM 129.91, -2.32, -1.8%) CEO Dimon, who warned about an approaching "economic hurricane." Shares of JPM surrendered yesterday's gain but finished above their low after bouncing off their 50-day moving average (128.34).
The broader market enjoyed an afternoon recovery that returned the S&P 500 to its unchanged level, but renewed selling pressure appeared in the afternoon.
Elsewhere among cyclical sectors, industrials (-0.6%) and the consumer discretionary space (-0.8%) finished near the S&P 500 while the technology sector (-0.3%) ended just below its flat line after reclaiming a chunk of its opening loss. The sector owed its outperformance to relative strength in top components Apple (AAPL 148.71, -0.13, -0.1%) and Microsoft (MSFT 272.42, +0.55, +0.2%), but they too faced some late pressure. Salesforce (CRM 176.07, +15.83, +9.9%) and HP (HPQ 40.34, +1.50, +3.9%) represented pockets of relative strength throughout the day after both companies reported better than expected quarterly results. Chipmakers failed to keep pace with the sector, sending the PHLX Semiconductor Index lower by 1.6%.
Health care (-1.4%) and consumer staples (-1.3%) finished near the bottom of the leaderboard due to broad-based losses. Archer-Daniels (ADM 86.67, -4.15, -4.6%) was the worst performer among staple stocks, falling from its best level in nearly four weeks back below its 50-day moving average (90.25).
On the upside, energy (+1.8%) spent the day in the green, building on its gain as the session went on. The sector's continued strength was supported by another uptick in crude oil, which climbed $0.40, or 0.4% to $115.33/bbl. Baker Hughes (BKR 37.41, +1.43, +4.0%) was the top performer in the sector, reclaiming yesterday's entire loss.
Treasuries added to their losses from yesterday with shorter tenors leading the retreat. The 2-yr yield rose 11 bps to 2.65% while the 10-yr yield rose nine basis points to 2.93%.
The Fed released its Beige Book for June, which noted that all Districts reported continued growth with most reporting slight or modest growth while four reported a slowdown. There was some softening in the retail sector and residential real estate due to high prices and high interest rates. Employment expanded modestly or moderately while one District saw a slowdown. Prices continued rising at a strong or robust pace with manufacturers maintaining the bulk of their pricing power.
Reviewing today's economic data:
- The May ISM Manufacturing Index increased to 56.1% ( consensus 54.9%) from 55.4% in April. A number above 50.0% is indicative of expansion. May marked the 24th consecutive month of expansion in the manufacturing sector, although the May reading was the second lowest since September 2020.
- The key takeaway from the report is that manufacturing activity picked up in May despite ongoing supply chain problems and pricing pressures. Still, sentiment regarding demand remained strongly optimistic.
- Total construction spending increased 0.2% month-over-month in April (consensus 0.6%) following an upwardly revised 0.3% increase (from 0.1%) in March. Total private construction increased 0.5% month-over-month while total public construction decreased 0.7%. On a year-over-year basis, total construction spending was up 12.3%.
- The key takeaway from the report is that, other than residential spending, there wasn't much strength in spending activity in either the private or public sectors.
- Job openings decreased to 11.400 mln in April from a revised 11.855 mln (from 11.549 mln) in March.
- The IHS Markit Manufacturing PMI fell to 57.0 in the final reading for May from 57.5 in the preliminary reading.
- The weekly MBA Mortgage Index fell 2.3% after falling 1.2% during the previous week.
The ADP Employment Change for May (Briefing.com consensus 295,000; prior 247,000) will be reported tomorrow at 8:15 ET, followed by weekly Initial Claims (consensus 210,000; prior 210,000), Continuing Claims (prior 1.346 mln), revised Q1 Productivity (Briefing.com consensus -7.5%; prior -7.5%), and revised Q1 Unit Labor Costs ( consensus 11.6%; prior 11.6%) at 8:30 ET, and April Factory Orders (Briefing.com consensus 0.7%; prior 2.2%) at 10:00 ET.
- Dow Jones Industrial Average -9.7% YTD
- S&P 400 -12.1% YTD
- S&P 500 -14.0% YTD
- Russell 2000 -17.4% YTD
- Nasdaq Composite -23.3% YTD
After Hours Summary: CHWY +20.9%, MDB +5.8%, PVH +4.3%, VEEV +3.5%, NTAP +3.4% higher on earnings; AI -19.5%, HPE -6.6% fall on earningsAfter Hours Gainers:
Companies trading higher in after hours in reaction to earnings/guidance: CHWY +20.9%, CRDO +9.8%, PSTG +9.7%, PATH +6.5%, MDB +5.8%, PVH +4.3% (also increases planned 2022 share repurchases to $400 mln), VEEV +3.5%, NTAP +3.4%, NCNO +1.8%, ESTC +1.5%, GME +1.4%, DSGX +0.9%, SMTC +0.2%
Companies trading higher in after hours in reaction to news: RPTX +16.6% (announces worldwide license and collaboration agreement with Roche for camonsertib), APRN +12% (launches new meal kit offering on Walmart.com), KIND +8.1% (authorizes new $100 mln share repurchase program), IGT +2.6% (signs ten year contract extension with Kansas lottery), GSM +2.5% (names new COO), SANA +0.6% (to develop manufacturing facility in Bothell), SAIL +0.4% (receives HSR clearance for pending merger with Thoma Bravo), CERN +0.3% (ORCL obtains approvals for proposed acquisition of CERN), DHX +0.2% (US PTO issues patent related to taxonomy), VAL +0.2% (receives contract termination notice for drillship VALARIS DS-11), BYD +0.1% (authorizes $500 mln increase to share repurchase program), BA +0.1% (DAL still trying to reach an aircraft deal with BA, according to Reuters)
After Hours Losers:
Companies trading lower in after hours in reaction to earnings/guidance: AI -19.5%, HPE -6.6%, S -3.1%
Companies trading lower in after hours in reaction to news: RDUS -6.3% (provides update on abaloparatide transdermal system; to cease all work on abalo-TDS), OWL -2.2% (stock offering by selling shareholder), ITI -1.1% (authorizes new $10 mln share repurchase program), MGY -1.1% (announces proposed block trade of 7.5 mln Class A shares by selling shareholders; intends to purchase 2 mln Class B shares), ANIP -1% (receives FDA approval for ANDA for Fludrocortisone Acetate Tablets), VCSA -0.5% (stock offering by selling shareholders), RIOT -0.3% (names new CFO), DAL -0.2% (DAL still trying to reach an aircraft deal with BA, according to Reuters), RYI -0.1% (acquires tool steel processor Ford Tool Steels), ABC -0.1% (provides long-term goals at Investor Day), TMX -0.1% (satisfies key closing condition for Rentokil merger), BRO -0.1% (acquires the assets of Dealer Specialties)
Amundi warns that corners of private equity market resemble ‘Ponzi schemes’
PE funds are selling assets to each other in ‘circular’ fashion, asset manager’s investment chief says
Europe’s largest asset manager has likened parts of the private equity industry to a “Ponzi scheme” that will face a reckoning in the coming years.
“Some parts of private equity look like a pyramid scheme in a way,” Amundi Asset Management’s chief investment officer Vincent Mortier said in a presentation on Wednesday. “You know you can sell [assets] to another private equity firm for 20 or 30 times earnings. That’s why you can talk about a Ponzi. It’s a circular thing.”
Public stock and bond markets leave little room for typical investment managers like Amundi, which has €2tn in assets, to hide their performance, as fluctuations in asset prices are easy to track daily or even in real time — a process known as marking to market.
Private equity houses, by contrast, typically lock up investors’ money for a period of several years, and information about whether their target companies have gained or shrunk in value becomes public only if they list the business or choose to disclose the price they sold it for to another buyer.
In the mean time, quarterly assessments are often sophisticated guesswork based on roughly equivalent assets in public markets, and shared privately with investors.
Often, private equity groups sell assets to other private equity groups. In 2021, they even struck $42bn worth of deals in which they sold portfolio companies to themselves.
Mortier said the incentives are for private equity firms to transfer assets between each other at inflated prices.
“Just because there’s no mark to market doesn’t mean there’s no risk,” said Mortier. “There are some very, very good opportunities, but there are no miracles. Eventually there will be casualties, but that might not be for three, four, or five years.”
Private equity firms have been flush with cash in recent years as they have been able to borrow at low interest rates, giving them enormous firepower to snap up companies. Globally, the private equity industry has more than $6tn in assets under management, according to a McKinsey report published in March.
They enjoyed their strongest ever start to a year in 2022 as they deployed vast cash piles accumulated during the pandemic. Buyout groups backed $288bn worth of deals in the first quarter, a 17 per cent rise compared with the first three months of 2021.
More mainstream investors, meanwhile, have been keen to find lucrative opportunities in this space as some parts of public stock markets have appeared overvalued, and bond yields have been historically low.
Mortier also expressed concern about public debt markets, in government and corporate bonds, noting that it is increasingly difficult to get deals done, particularly when the gap between the prices where investors can buy and sell has become unusually wide.
“It’s really concerning,” he said. “Banks are less and less doing their role of market making.” In part, that is because of regulation, which has tightened up since the 2008 financial crisis. “But as well, banks and traders are greedy. Regulators should probably have a look at this” as it could produce market accidents, he said.
Gapping down
In reaction to earnings/guidance:
- SPWH -9.4%, SPGI -7.6% (suspends FY22 guidance), APPS -4.8%, AMBA -4.4%, BARK -4.4%, CHPT -2.7%, DCI -0.5%
Other news:
- CNCE -18.9% (announced stock offering)
- CNMD -4.6% (announced private offering of convertible senior notes)
- SAVE -2% (disagrees with ISS recommendation on proposed transaction with Frontier)
- HCM -1.6% (recieves approval for TAZVERIK to be Used in Hainan Pilot Zone in China)
Analyst comments:
- GDRX -5.9% (downgraded to Neutral from Outperform at Robert Baird)
- TPX -4.8% (downgraded to Neutral from Overweight at Piper Sandler)
- POSH -2% (downgraded to Mkt Perform from Mkt Outperform at JMP Securities)
- FTS -1.8% (downgraded to Underweight from Equal Weight at Wells Fargo)
- GTES -1.5% (downgraded to Sector Perform from Outperform at RBC Capital Mkts)
- SEE -1.4% (downgraded to Underweight from Neutral at JP Morgan)
- MDT -0.6% (downgraded to Neutral from Overweight at Atlantic Equities)
Research Calls
- Upgrades:
- Blueprint Medicines (BPMC) upgraded to Buy from Hold at Jefferies; tgt lowered to $78
- Danaher (DHR) upgraded to Outperform from Sector Perform at RBC Capital Mkts; tgt raised to $310
- Enanta Pharmaceuticals (ENTA) upgraded to In-line from Underperform at Evercore ISI; tgt $39
- FEMSA (FMX) upgraded to Outperform from Neutral; tgt $90
- Home Bancorp (HBCP) upgraded to Buy from Neutral at DA Davidson; tgt $44.50
- Infosys (INFY) upgraded to Buy from Hold at HSBC Securities
- Noble Corporation (NE) upgraded to Buy from Neutral at BTIG Research; tgt $60
- Park Hotels & Resorts (PK) upgraded to Buy from Hold at Truist; tgt raised to $22
- Xylem (XYL) upgraded to Outperform from Market Perform at Cowen; tgt $75
- Downgrades:
- Coca-Cola FEMSA (KOF) downgraded to Neutral from Outperform at Bradesco BBI; tgt $60
- Fortis (FTS) downgraded to Underweight from Equal Weight at Wells Fargo
- Gates Industrial (GTES) downgraded to Sector Perform from Outperform at RBC Capital Mkts; tgt lowered to $14
- GoodRx (GDRX) downgraded to Neutral from Outperform at Robert W. Baird; tgt lowered to $7
- Medtronic (MDT) downgraded to Neutral from Overweight at Atlantic Equities; tgt lowered to $105
- Patterson-UTI (PTEN) downgraded to Neutral from Overweight at Piper Sandler; tgt raised to $22.75
- Poshmark (POSH) downgraded to Mkt Perform from Mkt Outperform at JMP Securities
- Sealed Air (SEE) downgraded to Underweight from Neutral at JP Morgan; tgt lowered to $62
- Sibanye-Stillwater (SBSW) downgraded to Sector Perform from Outperform at RBC Capital Mkts; tgt lowered to $13
- Tempur Sealy Int'l (TPX) downgraded to Neutral from Overweight at Piper Sandler; tgt lowered to $28
- Others:
- 1stdibs.com (DIBS) assumed with a Mkt Perform at JMP Securities
- Amazon (AMZN) resumed with a Mkt Outperform at JMP Securities; tgt lowered to $3450
- CF Industries (CF) initiated with an Equal Weight at Barclays; tgt $103
- Corteva (CTVA) initiated with an Overweight at Barclays; tgt $71
- eBay (EBAY) resumed with a Mkt Perform at JMP Securities
- Etsy (ETSY) resumed with a Mkt Outperform at JMP Securities; tgt $125
- First Northwest Bancorp (FNWB) assumed with an Overweight at Piper Sandler; tgt $19
- ICL Group (ICL) initiated with an Equal Weight at Barclays; tgt $12
- Mosaic (MOS) initiated with an Underweight at Barclays; tgt $59
- MP Materials (MP) initiated with an Outperform at BMO Capital Markets; tgt $50
- Nutrien (NTR) initiated with an Overweight at Barclays; tgt $116
- Squarespace (SQSP) initiated with a Neutral at Credit Suisse; tgt $25
Gapping up
In reaction to earnings/guidance:
- VSCO +9.1%, CRM +8.8%, WB +5%, CAE +4.1%, CPRI +2.9%, CONN +2.3%, HPQ +0.5%
Other news:
- NVGS +4.9% (names Mads Peter Zacho as CEO)
- LPI +4% (authorized $200 mln share repurchase program)
- AXSM +3.1% (Late-Breaking Presentations of Positive Results of the EVOLVE Trial of AXS-05)
- BITF +2.5% (reports May production)
- KYMR +2.3% (to Present Pre-clinical Data at the EULAR 2022 Congress Showing STAT3 Degradation Blocked Th17 Development and Prevented Rheumatoid Arthritis )
- LI +2.2% (May deliveries)
- KSCP +2.1% (deployed a K5 Autonomous Security Robot in a California park)
- DQ +2.1% (approves $120 mln share repurchase program)
- MCRB +1.9% (Presents Microbiome Therapeutic Research at the 2022 American Society of Clinical Oncology (ASCO) Annual Meeting)
- LICY +1.8% (Li-Cycle and Glencore enter into long-term commercial agreements and close Glencore $200 million investment in Li-Cycle)
- PTVE +1.7% (appointed Jonathan Baksht as CFO)
- NIO +1.6% (May deliveries)
- SIX +1.5% (appointed Gary Mick as CFO)
- XPEV +1.5% (May deliveries)
- GIAC +1.4% (agreed to combine with Freightos)
- THR +1.1% (acquired Powerblanket)
- EVEX +1% (partners with Porsche Consulting to define eVTOL global manufacturing logistics and supply chain strategy)
Analyst comments:
- ENTA +2.7% (upgraded to In-line from Underperform at Evercore ISI)
- PK +2.4% (upgraded to Buy from Hold at Truist)
- BPMC +1.9% (upgraded to Buy from Hold at Jefferies)
- DHR +1% (upgraded to Outperform from Sector Perform at RBC Capital Mkts)
- XYL +1% (upgraded to Outperform from Market Perform at Cowen)
Missed Payments, Rising Interest Rates Put ‘Buy Now, Pay Later’ to the Test
Affirm, Afterpay and Klarna grew rapidly during the consumer-spending boom. Investors have concerns as outlook looks cloudier.
“Buy now, pay later” companies promised a credit revolution that would change the way people pay for things. Rising delinquencies and a slowing economy are clouding that outlook.
Payment plans that allow shoppers to split up the cost of things such as clothing, makeup and home appliances were all the rage last year. The companies behind the plans saw their valuations surge. Scores of retailers rushed to add them at checkout. Block Inc. SQ -3.33% (formerly Square Inc.) in August announced a roughly $29 billion all-stock deal for Afterpay, one of the biggest companies in the business.
But late payments or related losses are piling up for the industry’s biggest players— Affirm Holdings Inc., Afterpay and Zip Co. ZIP -8.74% Their borrowing costs, meanwhile, are rising. Buy-now-pay-later companies sometimes rely on credit lines whose rates rise and fall along with the Federal Reserve’s benchmark rate, which has risen 0.75 percentage point so far this year and is poised to go up even more.
Investors, once enamored with the business, are backing away. Affirm AFRM -6.10% went public in January 2021 at $49 a share and rose to more than $170 by November. The stock closed at $28.50 Tuesday. SoftBank-backed Klarna Bank AB is looking to raise as much as $1 billion in a deal that could value it in the low $30 billion range, far below the roughly $46 billion valuation it achieved last year.
The young industry finds itself in a tricky spot at a time when the economy is slowing and, some fear, headed for a recession. Buy-now-pay-later companies boomed when consumers were flush with cash and buying goods at a feverish pace. How they fare in a downturn, when savings evaporate, spending slows and bad debts mount, is untested.
To weather the storm, Afterpay and Zip are slowing their new originations.
“We are putting a real focus on sustainable growth, strong unit economics and, critically, accelerating our pathway to profitability,” said Zip co-founder and Global Chief Operating Officer Peter Gray.
Klarna last week said it plans to lay off about 10% of its staff. It also has tightened lending standards “to reflect this evolving market context,” a spokeswoman said.
Affirm Chief Executive Max Levchin has sounded a more upbeat note. Buy-now-pay-later plans like Affirm that don’t charge late fees will be in greater demand during a downturn, he said on an earnings call in May. “It is our mission to improve people’s lives, and we will be prepared to meet this demand—but again—our approach is only to extend credit that we believe can and will be repaid,” he said.
The buy-now-pay-later business took off in a post-financial-crisis world of cheap funding and low delinquencies.
They rely less on—and in some cases bypass altogether—traditional credit scores and reports. That makes them appealing to people with limited savings and low credit scores. Subprime consumers accounted for about 43% of shoppers who applied for payment plans or loans at retailers’ checkout between the fourth quarter of 2019 and 2021, according to credit-reporting firm TransUnion, though they only made up about 15% of the U.S. adult population.
While consumer-loan defaults and delinquencies remain low across the board, there are signs surging inflation and the end of pandemic-era stimulus programs are causing more subprime borrowers to fall behind on their debts.
At Affirm, about 3.7% of outstanding loan dollars held on the company’s balance sheet were at least 30 days late at the end of March, up from 1.4% a year earlier. Affirm said the increase reflects a loosening of underwriting standards that it tightened earlier in the pandemic. Delinquencies were at historic lows “and that’s not how we intend to run the business,” the company’s finance chief said early last year.
Afterpay’s losses equaled 1.17% of total payment dollars processed during its latest quarter, compared with 0.9% for its latest full year ended June 2021. Zip said its “bad debts and expected credit losses” surged 403% in the last six months of 2021 compared with the same period a year prior. Zip said the increase was in part due to companies it acquired in 2021.
“The industry as a whole, which has seen bad debts spike, really missed that moment,” Zip Chairwoman Diane Smith-Gander said at a shareholder conference in Australia last week. “And we are now going to have to dig our way out of that.”
Rising delinquencies have prompted investors to demand higher yields on the packaged-up debt they purchase from buy-now-pay-later companies. Affirm’s most recent securitization in April priced at a weighted average yield of 4.61%, roughly 3.3 percentage points more than its February 2021 securitization, according to Finsight.
A spike in bad debt could increase the risk that banks and other lenders cut off the buy-now-pay-later companies, or demand much higher interest rates, said a former industry executive.
Rising interest rates mean some buy-now-pay-later companies are already paying more for funding. Much of the debt carries floating interest rates, meaning it gets more expensive when the Federal Reserve raises its benchmark rate.
Affirm has the ability to pass along some of the higher funding costs to merchants in the form of higher fees or to its borrowers because it charges interest. The company said most of its funding is from fixed-rate debt, and the impact of rising rates would be minimal through the next year.
Rate increases could prove more painful for companies such as Afterpay that derive most of their revenue from deals with merchants and late fees. Afterpay said it plans to rely more on its cash to fund receivables, reducing the need to tap its warehouse line.
“We believe that what we’re building will be resilient and a sustainable strategy over the long term for both sides of the ecosystem, merchants and consumers,” Block Chief Financial Officer Amrita Ahuja said of Afterpay on the company’s most recent earnings call.