Consumer Banking and Orange Juice
For all the talk about bringing back the Glass-Steagall Act that used to separate investment banking from consumer and commercial banking, one of the big stories in modern U.S. financial regulation is the push for big investment banks to build up their consumer-banking business. That's what Goldman Sachs and Morgan Stanley are doing:
Both firms have turned to more basic banking businesses, betting that the cachet of their brand names can overcome relative lack of experience in dealing with the deposits and loans of middle-class Americans.
The moves have surprised many and suggest capital-markets businesses have reached a turning point. “I would never have thought years ago that they would ever be doing this,” says Richard Kovacevich, Wells Fargo & Co.’s former chairman and chief executive. But as regulation and muted client activity hammers trading revenue, “you either shrink, or you try to replace” lost profits.
These are commercial decisions, but they are also influenced by regulation. Regulators view retail deposits as a more stable source of funding than wholesale funding. New capital regulation, and the Volcker Rule, have made it less appealing for banks to buy bonds, and more appealing for them to make consumer loans. The general bank-regulatory apparatus has tilted, since the crisis, to favor traditional banking over sales and trading.
Which is fine if your regulatory goal is to, like, get Wells Fargo to make more loans and trade fewer derivatives. But it is a little weird if your goal is to get Goldman and Morgan Stanley to do that. They're still going to trade a lot of derivatives. They are still, at their core, investment banks. If Glass-Steagall ever does come back, they'll end up mostly on the investment-banking side of the line. And if everyone in Washington is so serious about walling off investment banks from retail deposits, it's weird that current regulation is pushing investment banks to seek out those deposits.
Eventually, many years after open-outcry trading has vanished from its last market and all of the world's financial transactions are conducted by silent computers, someone will open a sort of Colonial Williamsburg of floor trading, where tourists can go and watch people in old-timey period costumes (boxy '80s suits, mesh trading jackets, big cell phones) stand in a pit shouting and signaling and pretending to trade commodities. And when that happens, I'm pretty sure that the frozen concentrated orange juice contract will be the main attraction. It is the king of commodities, if -- as is likely -- your knowledge of commodities trading comes from "Trading Places," where it both provides the climactic plot point and appears in the famous breakfast-based explanation of commodities trading. And just as a product, it is so quaint. The name of the commodity itself is a throwback to a distant, more innocent, more food-science-y time. Who drinks frozen concentrated orange juice? No one, really:
Americans drank less orange juice in 2015 than in any year since Nielsen began collecting data in 2002, as more exotic beverages like tropical smoothies and energy drinks take market share and fewer Americans sit down for breakfast.
When they do drink orange juice, they aren’t drinking it from concentrate.
That's from this Wall Street Journal article about the waning of the frozen concentrated orange juice futures market, which went electronic in 2012 and which was declining long before that. People miss the glory days of the 1980s, like floor trader Roger Corrado:
“Nothing gave you a bigger move than orange juice,” Mr. Corrado said. “We’d have people collapsing in the ring and being whisked to the nurse’s office.”
Today, Mr. Corrado is giving up. The market is a ghost town, he said.
“It’s like playing chess against a computer. You’re not going to win,” he said.
The weird thing is that an "incurable bacterial disease, citrus greening, has slashed the crop in half over the past few years," which you'd think would be an opportunity for excitement in the futures market. But, nah: Most producers "negotiate multiyear supply contracts directly with grove owners," and the frozen concentrate contract isn't that useful a hedge for the much bigger fresh juice market anyway. In some ways the decline in the contract parallels the decline in the product: Decades ago, orange juice from concentrate was a high-tech solution to the problem of transporting orange juice, appealing both for its practical usefulness but also for its space-age impressiveness. Orange juice futures contracts had a similar glamor: Those pits! Those hand signals! It was a long way away from Florida's orange groves. Now, people like artisanal organic food, not high-tech space food, so concentrated orange juice has lost its appeal. And long-term contracts to buy orange juice can do a lot of the work of listed futures, in a more natural, less stylized, less exciting way.
On Friday, the Wall Street Journal reported that Carl Icahn had been looking to sell his shares of Herbalife, and that Jefferies had contacted potential buyers on his behalf, and that Bill Ackman had been one of the potential buyers. And I went and spun a theory of how that could be a pretty smart trade for both Icahn and Ackman. But I forgot that it's Herbalife, and Icahn, and Ackman, and August, and that if an explanation makes sense then that means it's probably wrong. No, it turns out that Ackman had told people that he'd been approached to buy some of Icahn's shares, and that, while he wasn't looking to cover his short position, he was willing to help Icahn out if he couldn't find enough buyers, just out of the goodness of his heart. (And to get Icahn out of the stock: "Herbalife is a confidence game," said Ackman. "Carl is the chief confidence guy.") And of course, on hearing this, Icahn ... I mean, obviously:
Herbalife Ltd. backer Carl Icahn said he bought an additional 2.3 million shares in the nutrition company following remarks by fellow billionaire Bill Ackman that the investor has been trying to sell his stake.
“I continue to believe in Herbalife,” Icahn said in a statement on his website. “It’s a great model that creates a great number of jobs for people. Ackman may be a smart guy but he has clearly succumbed to the same dangerous (and sometimes fatal) malady that afflicts many investors -- he’s developed a very bad case of ‘Herbalife obsession.”’
Was Icahn actually looking to sell before Ackman went public? (He says he has "never given Jefferies an order to sell any of our Herbalife shares.") Did Ackman really go public in order to make a deal more likely? (How?) Who cares, really; it is just sort of stock-market Wrestlemania:
“Bill Ackman tried to play us this morning, and Carl Icahn played Bill Ackman this afternoon,” said Tim Ramey, an analyst at Pivotal Research Group and a longtime defender of Herbalife. “It’s so beautifully played on Icahn’s part.”
Sure, whatever. "It amazes me that a guy who hasn’t any knowledge of my internal investment thinking believes he is in a position to go on television to tell the world what I AM thinking," said Icahn, and I too have no knowledge of his internal investment thinking, so I do not want to make any categorical statements. But if you had to guess whether Icahn bought more shares on Friday (1) because he did detailed valuation work that convinced him it was time to add to his Herbalife exposure a few hours after Ackman said he was a seller, or (2) to make Ackman look silly, surely you would take choice 2, no?
We talked last week about active management as a tool for allocating capital to businesses, and what do you make of this? The primary force that moved Herbalife shares on Friday -- they closed down 2.3 percent on the Ackman news, and then "surged as much as 8.3 percent to $65.54 in late trading after Icahn posted the statement" -- wasn't valuation, or the company's prospects, or careful decisions by dispersed active managers about the most promising places to allocate capital. It was, basically, spite. (Also, Herbalife spends more money buying back stock than it gets from the capital markets.) The stock market may get mostly efficient results, but it goes through a lot of nonsense to get there.
Hey look, initial public offerings will be back next week, but not for long:
Companies in a wide variety of U.S. industries plan to go public after the long weekend. The level of new issuance should resemble what would normally be expected given record stock prices and historically low volatility.
At the same time, the window for offerings is expected to shut about six weeks later amid political uncertainty ahead of the presidential election, bankers and analysts say.
In an earlier life, I was a mergers-and-acquisitions lawyer, and for some reason people love to announce mergers on, like, Christmas. The schedule was bad. And then I became a capital-markets banker, and I was struck by how much more civilized life was. Companies would come to me and say they wanted to do an offering in late August, and I'd be like "naaaaah, the market kind of takes that month off." The market as a mechanism for allocating capital has its faults, but as a coordination mechanism for letting everyone take vacation in the last two weeks of August it is pretty great.
Elsewhere, there are a lot of bought deals:
In a bought deal, companies sell a block of stock to a bank or banks at a discount. The bank then bears the risk of selling it to investors.
This year, U.S. companies have issued $62.4 billion of stock through 151 bought deals, according to Dealogic. Both figures are year-to-date highs, and the value of bought deals stands just $500 million from a full-year record.
It helps that volatility has more or less vanished: A bought deal is risky for the bank that buys it, but if stocks never go up or down much, the risk is that much lower.
We talked last week about the National Futures Association's complaint against teen trader Jacob Wohl, and I don't really want to talk about him ever again, but I do feel sort of obligated to give you the other side of the story, so here it is:
In a telephone call with Yahoo Finance, Wohl’s father, David, who has practiced as a criminal defense lawyer for 27 years, gave a different version of events. He called the NFA’s complaint “frivolous” and “not professionally written.”
He also said that “two, maybe three guys” showed up “not dressed like professionals, wearing polo shirts and cargo shorts or something like they’re heading to the beach” and “ambushed” Wohl by “pounding on his door” with “no notice.”
You can actually -- I am sorry -- see some pictures of the NFA examiners showing up at Wohl's address; I would characterize their pants as long and their vibe as not particularly beachy, but you can judge for yourself.
We talked on Friday about short seller Carson Block's claims that St. Judge Medical pacemakers and defibrillators could be hacked, with possibly fatal consequences, and I expressed skepticism that anyone would go to the trouble of hacking a pacemaker just to kill someone. Obviously this is not legal advice, but it seems like there would be easier ways. I was confirmed in that view by St. Jude's response to Block's claims:
The report claimed that the battery could be depleted at a 50-foot range. This is not possible since once the device is implanted into a patient, wireless communication has an approximate 7-foot range. This brings into question the entire testing methodology that has been used as the basis for the Muddy Waters Capital and MedSec report. In addition, in the described scenario it would require hundreds of hours of continuous and sustained “pings” within this distance. To put it plainly, a patient would need to remain immobile for days on end and the hacker would need to be within seven feet of the patient.
I feel like if you followed someone around for days with electronic equipment, always keeping within seven feet of him, and then he died of pacemaker malfunction ... you'd be a prime suspect? Anyway I also suggested that pacemaker-hacking-murder would be a good plot for a financial thriller -- though you'd have to get rid of some procedural realism to make it, you know, thrilling -- but it turns out it was already the plot of a "Homeland" episode, so never mind on that one.
People are worried about unicorns.
It often feels like these "people are worried about" sections have no real narrative arc: People worry about bond market liquidity, and then they worry about it some more, but like the weather, they never do anything about it. Sure, sometimes they start electronic bond-trading platforms, but then they shut them down pretty quickly. And actual events in the world -- the liquidation of a bond fund due to liquidity, a drop in bond prices that doesn't spark a liquidity panic -- seem not to do much to change the discussion. It's just the same liquidity worries, over and over again.
So it's nice to see that people worried about unicorns for a long time and the unicorns did something about it:
Some smaller start-ups, like the live-streaming app Blab and the on-demand private chef company Kitchit, have collapsed into Silicon Valley’s dead pool. Other young companies have laid off staff. And many entrepreneurs are no longer able to demand whatever valuation they please for their companies.
Yet it is precisely these adaptations that have allowed many Silicon Valley start-ups to stick it out — for now, at least.
“The start-up world did heed the warnings,” said Max Levchin, a former employee and a founder of PayPal and the chief executive of Affirm, a lending start-up in San Francisco.
One startup chief executive officer says: "Now you’re encouraged to not run out of money and make sure you’ll be around." Another says: "People are just cautious. It's healthier." A third found that the unicorn worrying "encouraged folks to behave in whatever way would give them the greatest chance to succeed," which in his case meant selling to Apple. "Funding for just anything under the sun has gone away," says one venture capitalist, but "there just hasn’t been much of a downturn," says another. The Enchanted Forest has gotten a bit less enchanted, a bit more sensible. The unicorns have knocked off the wild partying and gotten down to work.
Obviously the exciting narrative would be for a bubble in startup valuations to end with a dramatic pop, with mass bankruptcies of startups and venture capitalists and noticeable effects in the real world. But that's not the only possibility. The startup market is largely unlevered and private; you can't track the minute-by-minute prices of the Unicorn 100 Index or whatever, and momentum traders aren't piling in and out of the hottest unicorns. If valuations got a bit too high, the outcome may not be a wild crash; it may just be startups with somewhat lower valuations working somewhat harder to justify them. The worrying might actually work.
There’s no shortage of incubators and accelerators to help fledgling ventures get off the ground. But there’s not much of a support system for more mature, small companies with proven business models.
And General Electric is a software startup, sure, why not.
People are worried about stock buybacks.
Here's a view that they are unsustainable:
Aswath Damodaran, a professor at New York University’s Stern School of Business, sees this as the market’s biggest risk. Mr. Damodaran, who is considered an authority on valuation, says S&P 500 companies through the first two quarters of the year collectively returned 112% of their earnings through buybacks and dividends. That is the highest since 2008 and well above the 82% average over the past 15 years, he said in a blog post last week.
Mr. Damodaran, who likes to be provocative, says with rates this low, traditional valuation metrics are distorted. Instead, the inability of companies to keep paying off their investors will cause the next downturn. “This is the weakest link in this market,” Mr. Damodaran said in an interview. “We know cash flows will go down. What we don’t know is what the market is pricing in.”
This makes perfect sense. If you view the public stock market as a mechanism for companies to give money to shareholders, then stock prices should go up when the companies give the shareholders more money, and go down when the companies run out of money to give the shareholders. There is nothing particularly weird about that. Obviously if you imagine the stock market as a mechanism for companies to raise capital, and for investors to allocate that capital to the companies with the most attractive investment opportunities, then it does seem weird to base your valuation on something as tangential as buybacks. But that seems like the wrong way to imagine the stock market.
People are worried about bond market liquidity.
I mean, it's the last week of August, it would be a little weird to worry about bond market liquidity now. Take the week off, bond market liquidity! I've got nothing.
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