☀️☕ 5 cents on the Dollar for Archegos? Grüezi, Credit Suisse!

2 February 2023

Happy Thursday!

US large-cap S&P 500 closed 1.05% UP ▲ Tech-heavy Nasdaq Composite closed 2% UP ▲▲Pan European STOXX Europe 600 closed 0.08% DOWN 🔻 HK’s Hang Seng Index closed 1.05% UP ▲ Japan’s Nikkei 225 closed 0.07% UP ▲

📝 Focus

5 cents on the Dollar for Archegos? Grüezi, Credit Suisse!

📊 In the Markets

Disinflation! Prices still shooting up… but less quickly!US Manufacturing catching a chill, Labour market… still red-hotPeloton now peddling subscriptionsAdani yanks its “completed” share sale

📖   MoneyFitt Explains

🎓  Inflation, Deflation and Disinflation 

📝 Focus

5 cents on the Dollar for Archegos? Grüezi, Credit Suisse!

It’s looking like the big investment banks that lent money to Archegos Capital Management, the US$36 billion family office that vaporised spectacularly just under two years ago, will be getting back somewhere between 5 and 20 cents back for every dollar, based on cash left in its trading accounts. The banks, featuring leading lights of the industry such as Credit Suisse, Deutsche Bank, Goldman Sachs Group, Morgan Stanley, Nomura and UBS, lost more than $10bn from the blow-up of Archegos. Credit Suisse was, by some reports, the slowest to move and the biggest loser of the lot, with losses of over $5bn.

New York-based Archegos was set up by Sung Kook “Bill” Hwang, formerly a stock analyst with storied hedge fund Tiger Management, founded by the legendary Julian Robertson. He went on to set up his own “Tiger Cub” hedge fund called Tiger Asia with Robertson’s backing. In 2012, Tiger Asia and Hwang pled guilty to charges from the SEC of insider trading and market manipulation in Chinese bank stocks and had to pay $44mn in penalties. After that, Hwang converted Tiger Asia into his own family office, meaning he ran his own personal fortune but nobody else’s money.

Starting in about 2020, the investment strategy involved making concentrated bets through buying a small number of shares, mostly using money borrowed from banks — very much like buying stocks on margin but using “total return swaps”, which obscured his ultimate ownership from authorities and the other banks — an important point for later.

Based on Archegos’s estimates of those issuers’ floats, this is what they held:

– GSX Techedu Inc. (“GSX”) – Over 70% of outstanding shares;

– Discovery Class A – Over 60% of outstanding shares;

– IQIYI Inc. – Over 50% of outstanding shares;

– ViacomCBS – Over 50% of outstanding shares;

– Tencent Music Entertainment Group (“Tencent”) – Over 45% of outstanding shares; and

– Discovery Class C – Over 30% of outstanding shares.

– (There were also holdings in Baidu and Vipshop, among others.)

“We allege that Hwang and Archegos propped up a $36 billion house of cards by engaging in a constant cycle of manipulative trading, lying to banks to obtain additional capacity, and then using that capacity to engage in still more manipulative trading,”

As Archegos kept buying more of these few stocks, the prices went up, as happens when a lot of money is thrown at a stock. With higher prices, Archegos made some great profits on the shares it had bought earlier. But more than just profits, its assets had also therefore gone up. Banks lend against assets, so with more assets, Archegos could borrow more (and more and more) from those same banks against those inflated assets to use in buying… those same few stocks. Which then went up, boosting Archegos’ assets, which meant that those banks (all of whom were aware of his history with the SEC) would lend him more money, which he would then use to buy…

“No. It is a sign of me buying 😂”

So at its peak, the fund was worth US$36 billion, from about $4bn in 2020. The trouble was that it was built on $160bn of borrowings from those banks ($20bn of which was from CS.) Which meant that if even one of those very few stocks dropped, the banks would make the equivalent of a “margin call” (see below) and Archegos would have to come up with a lot more cash or the banks would sell the stock, potentially pushing down the price further, which would lead to more margin calls and more forced selling in that stock and (to raise cash) any other stock held through swaps at the bank, which would push all the prices down further and…

“But the house of cards could only be sustained if that cycle of deceptive trading, lies and buying power continued uninterrupted, and once Archegos’s buying power was exhausted and stock prices fell, the entire structure collapsed, allegedly leaving Archegos’s counterparties billions in trading losses.”

That’s when ViacomCBS (now Paramount Global) used its high price — up 800% in a year thanks largely to Archegos’ aggressive buying — to try and sell $3bn worth of shares to raise some money. At such a high price, the takeup was feeble, sending the shares down… triggering exactly the vicious cycle of death spiral described above. Morgan Stanley and Goldman Sachs quickly exited their positions and emerged relatively unscathed. But any bank too trusting, slow or dumb to sell out of its Archegos exposure before the other banks would get smoked. Grüezi Credit Suisse!

Margin Calls – a mini-explainer

A margin call happens when the value of a stock or a portfolio of securities in an account drops below a certain level, known as the maintenance margin, a certain percentage above any amount borrowed from the broker to buy those securities.The account holder must deposit additional cash or securities to meet the margin requirements.If the account holder cannot do so, the brokerage will sell the securities in the account at whatever price it can get to raise the cash needed to reduce or entirely settle the sum borrowed.

📊 In the Markets

Disinflation! Prices still shooting up… but less quickly!

In a sign that Wall Street can be dumb in the short term, the market sold off a little after the Federal Reserve, the US central bank, (a) raised interest rates by 0.25% and (b) said that “ongoing increases” to interest rates would be appropriate. Both were almost unanimously expected, with a probability of nearly 100% as implied by the futures market and based on *everything* that Fed officials have been saying for at least the last three months.

But then, in his post-release 2:30pm press conference, Fed chair Jay Powell acknowledged that inflation was starting to ease, as has been visible in publicly released government data for almost half a year. Markets sharply reversed course and shot up to close near their highs for the day.

But he did drop in a word that hasn’t been seen in a long time: Disinflation 🎓

“We can now say for the first time that the disinflationary process has started. We can see that and we see it really in goods prices so far,” 

In its post-meeting statement, the Fed said that “ongoing increases in the target range will be appropriate… to return inflation to 2 per cent over time.” Powell added that the Fed would still need to be restrictive for some time, and the central bank had more work to do, yada yada yada, with no real hint of a pause in hikes. 

“If the economy performs broadly in line with… expectations, it will not be appropriate to cut rates this year.”

But the futures markets, based on the CME FedWatch Tool, are now implying not only a cut at the December meeting but (based on the highest probability) a steeper one than expected before Wednesday’s rate hike.

Tuesday, before the Wednesday rate hike to 4.50-4.75%. First expected rate cut, based on the most popular (modal?) implied probability is 0.25% in December
Today, after the Wednesday rate hike to 4.50-4.75%. First expected rate cut is still in December, but now 0.50%, with a not insignificant 19% probability that rates are lower at the end of this year than where we started it. This is not at all what Jay Powell is saying.

US Manufacturing catching a chill, Labour market… still red-hot

Meanwhile, the US manufacturing sector contracts for the third month in January, with activity levels at their weakest in more than two and a half years. The Institute for Supply Management (globally, similar surveys are called Purchasing Managers’ Indexes, or PMIs) said factory activity index dropped to 47.4, its lowest since May 2020 and showing shrinkage by coming in below the threshold of 50 for the third month running.

And yet demand for US workers rose more than expected in December, showing that the strong US labour market remains strong despite the Fed’s best efforts to cool the economy and kill off the 40-year high inflation we’d been seeing. The number of vacancies available rose by over half a million job openings in the economy in just a month, while Wall Street’s Finest were confidently expecting a drop of almost a quarter million.

The biggest move was in the vast services sector, in areas such as accommodation, food services and retail. This explains the apparent disconnect between what we see in manufacturing and the labour market.

Peloton now peddling subscriptions

Shares in Peloton, the stationary bike darling of the pandemic lockdown set, surged 26% after announcing fourth quarter revenues than expected by Wall Street’s Finest and coming in with a smaller loss as well.

Key to the results is progress on new CEO Barry McCarthy’s pivot away from hardware sales, which is capital-intensive, lumpy and unprofitable, to providing a smoother, subscription-based recurrent income stream. For Peleton, that’s “Fitness-as-a-Service”. In the process, he shed 5,000 jobs out of the 9,000 he started with, and the company now not only sells used bikes but also uses third-party retailers.

Adani yanks its “completed” share sale

Raising way more questions than it answers, Adani Enterprises abruptly called off its US$2.4 billion share sale early on Thursday morning.

The deal had completed on time, on Tuesday, apparently with much support from fellow tycoons in India but little retail involvement, but on Wednesday, group company stocks plummeted again, with shares in Adani Enterprises plunging 28%, meaning investors in the issue were facing an instant loss of some $700mn.

Given these extraordinary circumstances, the Company’s board felt that going ahead with the issue will not be morally correct.”

“Given the unprecedented situation and the current market volatility the Company aims to protect the interest of its investing community by returning the FPO proceeds and withdraws the completed transaction,” the company added.

After the share sale was pulled, the price of US dollar-denominated bonds issued by Adani companies fell. Since bond yields (the interest rate from the coupon payments you get at the price) move inversely to prices, yields went up, e.g. Adani Green Energy’s 2024 bond yields rose to 15.45% from 12.1%.

India’s market regulators are said to be looking into several of the allegations made by Hindenburg Research and examining the share price collapses across the Adani Group. Hindenburg’s 24th January short selling report has triggered a US$86 billion collapse in market capitalisation of the seven listed Adani Group companies.

📖 MoneyFitt Explains

🎓 Inflation, Deflation and Disinflation 

Inflation is basically a general increase in prices in an economy over a period of time. 

When this happens, money’s value, or purchasing power, goes down. Inflation is usually caused by too much demand for something relative to how much is available or by the cost of producing (or importing) something going up. Both can lead to a vicious cycle of rising prices, usually when higher prices become expected and built into wage demands.The Consumer Price Index is a way of measuring inflation in an economy based on the increase in the overall price of a “basket” of items that an average individual would spend on. (There are many measures, but the “CPI” is the most commonly used.)

Deflation is the opposite: A decrease in the general price level of goods and services. This sounds good, but it can be as damaging in a different way as buyers may sit on the sidelines and wait for lower prices, thereby sending economic activity through the floor, while their debt burden goes up.

Disinflation, on the other hand, is a decrease in the rate of inflation, meaning that prices are still going up, but not as quickly as before on either a month-on-month basis or year over year. This is generally seen as a good thing, especially if inflation is above the target rate.

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