Jobs Report eases concerns over higher interest rates. Yet inflation risks are still looming.
The main concern in the stock market is not earnings, which are up this year, but that an overheating economy will prompt the Federal Reserve to curb its bond buying program and raise short-term interest rates. term.
The May employment report released on Friday was reassuring, as non-farm workforces increased by 559,000, but below the consensus estimate of 650,000.
Stocks rose and Treasury yields fell as the
The index gained 0.9% on Friday, to 4,229.9, just short of its May high and up more than 12% for the year. The yield on the benchmark 10-year Treasury index fell 0.07 percentage points, to 1.56%, placing it in the lower half of its three-month range, as investors put aside fears that the Fed is reducing its bond purchases in the coming months. month.
âThe ‘in the middle’ jobs report shows an economy recovering quickly, but not too quickly,â wrote Matt Peron, director of research at Janus Henderson Investors. “This gives the market more time before the Fed cuts (or worse), when an employment report ‘too strong’ would have raised fears of a cut sooner rather than later.”
The willingness of Treasury investors to accept ultra-low yields remains a major source of support for the stock market. Jim Bianco, the director of Bianco Research, wonders how long this will last. âYou have negative real returns with rising and high inflation,â he says. April’s consumer price index rose 0.8% and the May report, released on Thursday, is expected to show an increase of 0.4%. Inflation risks were highlighted in the May jobs report, which showed a 0.5% increase in average hourly earnings. Over the past two months, they have increased at an annualized rate of 7%.
Bianco says consumer prices could climb nearly 4% this year: âThe problem is that the three-year high CPI is not suitable for a 10-year rate of 1.6%.
Even if inflation moderates, as the Fed expects, it is still expected to settle around 2.5% over the next five years, leading to negative inflation-adjusted yield on Treasuries.
Bianco believes the 10-year Treasury is heading towards 2% in the coming months, which could cause “indigestion” for the stock market, as will the rate hike in the first quarter that hit growth stocks. The S&P 500, he notes, is not cheap, trading at around 23 times the expected earnings for 2021.
While the Treasury market has generated negative returns this year, municipal bonds are in the dark.
“Muni summer: Tons of cash, rare bonds,” was the title of a recent report by BofA Securities analyst Yingchen Li, who wrote about the likely demand resulting from large inflows into muni funds, as well as reinvestment of bond buybacks and interest payments.
As a result, municipal bond yields have rarely been lower and the market has rarely been so expensive relative to Treasuries.
The 10-year benchmark munis with triple A ratings yielded less than 1% on Friday, barely 60% more than the 10-year Treasury. This relationship stood at 75% at the end of 2020 and has averaged around 80% for most of the past five years. The reduced percentage decreases the after-tax advantage of holding munis over treasury bills and other taxable bonds.
It is difficult to argue for the munis, which are vulnerable to higher Treasury yields or a shift to a more typical spread relationship with Treasuries.
Spin-offs have historically generated good returns for investors.
Big scores include
(ticker: PYPL), which has increased sevenfold since its split by
(EBAY) in 2015. More recently,
(CARR), the air conditioning equipment maker, has seen its shares triple, to $ 46, since it exited United Technologies a year ago when it merged with Raytheon. (Barron spotted Carrier’s potential in an April 2020 article.)
The spinoffs can allow businesses to showcase high growth businesses like PayPal or allow small businesses to thrive on their own.
(MRK) dropped last week, could be another winner. This is a classic derivative situation. Organon is a group of non-core Merck companies – off-patent drugs sold primarily overseas, biosimilars, and a women’s health company – that might do better as an independent business.
âYou can easily see how this activity could have been lost within Merck and under-managed compared to the rest of the portfolio,â says James Hounsell, senior research analyst at Smead Capital Management, a shareholder in Merck. âThat’s when the magic happens with the fallout. “
The shares are trading around $ 34, giving the company a market value of $ 8.6 billion, plus about $ 9 billion in net debt. Merck shareholders received one Organon share for every 10 Merck shares. Organon is trading for just six times 2020 earnings of $ 5.90 per share. Similar gains are expected this year.
Organon is not as cheap when valued against the expected 2021 earnings before interest, taxes, depreciation and amortization, or Ebitda, of $ 2.3 billion, based on its enterprise value of equity value plus net debt. Then it trades around eight times, according to mature pharmaceutical companies.
On an Investor Day in May, Merck forecasted $ 6.1 billion to $ 6.4 billion in revenue in 2021 for Organon and annual sales increases in the low to mid-range figures. The dividend has not yet been set, but based on Organon’s financial forecast it could be around 3%.
The main drivers of the business are expected to be an implantable female contraceptive called Nexplanon and biosimilars, which are generic versions of bioengineered drugs.
âThis is a stable and predictable business with low to mid-digit organic growth,â said Kevin Ali, CEO of Organon. Barron. He is optimistic about the growth outlook for the women’s health sector, which now accounts for around 25% of revenue, as well as the opportunity for potential acquisitions.
Given its low price-to-earnings ratio, Organon has good upside potential if it can meet its financial goals.
Bankruptcies usually mean shareholders are devastated.
Hertz Global Holdings
(HTZGQ) turns out to be an extraordinary exception.
Periods of vacuum in the rental car industry led to a bidding war for the company in bankruptcy court. The result: creditors are paid in full and shareholders can really expect a significant payment.
Hertz shares rose more than 50%, to $ 6, after a group of investors led by Knighthead Capital Management, Certares Opportunities and funds managed by
Global management of Apollo
(APO) won an auction last month for the company which will likely see Hertz exit Chapter 11 by the end of June. Hertz stock could see further gains as the company is valued at a lower price than its rival
Budget Opinion Group
(CAR), whose shares have risen more than 100% this year, to $ 85.
Avis has a market value of $ 6 billion. A similarly sized Hertz, with projected net debt of $ 1 billion or less, will come out of bankruptcy with a better record than Avis, which has approximately $ 3 billion in debt.
Car rental companies are expected to thrive this summer – and beyond – as a shortage of vehicles drives up prices. Higher prices for used cars mean less depreciation when rental companies sell their cars. The industry stands to benefit as an oligopoly dominated by Hertz, which also owns the Dollar and Thrifty brands, Avis Budget and the private company.
Hertz shareholders will receive a package consisting of approximately $ 1.50 per share in cash, a 3% stake in the reorganized company, and warrants for 18% of the company with a rare 30-year term. Warrants represent most of the value. The long maturity (most warrants have a term of 10 years or less) should make them valuable once they start trading.
Hertz financial advisers valued the package at $ 7.36 a share, but it could ultimately be worth more.
âThe complexity of bankruptcy and its emergence has created an opportunity for current and potential shareholders,â said Andy Taylor, managing director of Carronade Capital, an investment firm in Darien, Connecticut, which has been actively involved throughout. along the restructuring. “If revamped Hertz closes the valuation gap to Avis, HTZGQ holders are expected to make $ 10 or more.”
Hertz investors can be reassured that the Knighthead / Certares investor group is investing around $ 3 billion to buy new shares in Hertz.
Investors passionate about the car rental industry have focused on Avis because many are unable or unwilling to own shares in a bankrupt company. That should change when Hertz emerges with a potential value of around $ 6.5 billion.
The energy sector has been in its best shape for years, thanks to rising oil prices, industry capital discipline, a new focus on dividends and investor pressure to change climate change that curbs spending on new oil and gas projects.
At the same time, the world needs a lot of oil and demand prospects are good, at least for the next decade. Morgan Stanley’s Martijn Rats recently predicted that demand for oil could rise by around 7%, reaching a peak of 107 million barrels per day, by the early 2030s, and most estimates point to a Global demand for natural gas stable to higher over the next 10 years.
Morgan Stanley’s Devin McDermott is bullish on
(XOM), whose shares are up 49% this year to $ 61.45 and are returning 5.7%. He recently wrote that Exxon’s dividend, which looked vulnerable in 2020, is expected to have its “strongest hedge since 2012” this year, based on ample free cash flow forecast using the current “band” current and future energy prices. He has an overweight rating and a target price of $ 71.
It is also bullish on
Write to Andrew Bary at [email protected]