Mar 25, 2021

Axios Capital

We've reached the last Axios Capital of Q1, and it's a good one!

  • In this week's issue I look back on an astonishing year in the markets, and write about everything from housing bubbles to vintage NFTs, retirement plans and cat bonds.
  • It's a jam-packed 1,711 words, which will take you about 6 minutes to read.

As ever, all feedback gratefully accepted at felix@axios.com, and please tell your friends to subscribe. It's entirely free, unlike Investor's Business Daily, which just cost News Corp $275 million.

1 big thing: A year of beta

Illustration: Aïda Amer/Axios

Everything has gone up. The market hit rock bottom this time last year, and since then has moved steadily upwards in a rally notable for both its undifferentiated smoothness and for its magnitude.

Why it matters: Never before has the market swung so swiftly from extreme pessimism to extreme optimism. Over the past year the S&P 500 has moved from being at a three-year low, to rallying by an astonishing 76% and hitting new all-time highs.

  • Everything else went up, too. Tech stocks, retail stocks, venture capital, private equity, credit, crypto, real estate, you name it.

The big picture: If investment returns are separated into beta (market returns) and alpha (idiosyncratic investment-skill returns) then the past 12 months have been all about the beta.

  • There's not much need to pay a hedge-fund manager or private-equity titan two-and-20 in an attempt to get a 15% return, if an S&P 500 index fund can return 75% in the same timeframe.

Driving the news: Leon Black, the larger-than-life founder of Apollo Global Management, abruptly stepped down from his job this week; shares in the company gained about 5% on Monday, the day the announcement was made.

  • Our thought bubble: As far as investors are concerned, Black hasn't been adding value for the past year. He's famous as someone who can see around corners, time the market, and catch falling knives — all skills that are in low demand.
  • Black's connections to Jeffrey Epstein, meanwhile, were a continuing embarrassment to the company.

Be smart: At some point, investment skill will start paying off again. But for the past year, making money in the market has been a bit like shooting fish in a barrel.

The bottom line, from Axios' Dan Primack: "For the time being, the smart money has been rendered irrelevant."

2. Penny-stock fervor
Data: FINRA; Chart: Sara Wise/Axios

Penny stocks have a bad reputation, for good reason. The OTC markets, where they trade (it stands for over-the-counter, not that there's a counter anywhere) are notorious for being home to sharks and swindlers.

Why it matters: Right now, the OTC markets have never been hotter. Total volume was $84 billion in February, up from $33 billion in October.

  • More worryingly, the stocks being traded have gotten ever more speculative: While the average price per share was 63 cents last March, by February that number had dropped to just 4 cents.

The big picture: As the amount of speculation rises, on both the OTC markets and the regular stock exchange, so does the probability that people with significant shareholdings in beaten-down, struggling companies — maybe senior executives or board members — will wake up one morning to find their shares worth a life-changing amount of money. When that happens, it makes sense for them to cash out.

  • Driving the news: In recent weeks, GameStop, last trading at about 5,000 times forward earnings, has lost its CFO, chief customer officer, and no fewer than eight board members.
  • A lot of the turnover is linked to the new agenda of Chewy co-founder Ryan Cohen, who has joined the board and is trying to turn the company around. By the same token, however, it has to be tempting for large shareholders to simply call in rich. It's a lot easier to sell all your stock if you no longer work for the company.
3. The crisis that wasn't, and the crisis that was
Data: YCharts; Chart: Axios Visuals

The economic crash was bad, but it turned out not to be nearly as bad as many economists feared.

Flashback: A year ago this week, economist Nouriel Roubini published a column in which he speculated that we could be entering a "Greater Depression" even harsher than the Great Depression of the 1930s.

  • We wouldn't have a V-shaped recovery, he wrote: "Rather, it looks like an I: a vertical line representing financial markets and the real economy plummeting."
  • St. Louis Fed president James Bullard was also highly bearish, predicting that the U.S. unemployment rate would hit 30% in the second quarter.

The reality was much less dire. Unemployment spiked to 14.8% in April and then rapidly fell back; it's now 6.2%, which is where it was in July 2014.

  • Total employment stands at 143 million, well below pre-pandemic levels but still just back to where we were at the beginning of 2016.
  • U.S. GDP now looks set to reclaim its pre-pandmic levels either this quarter or next.

Context: Roubini was right that the U.S. would fail to implement "widespread COVID-19 testing, tracing, and treatment measures, enforced quarantines, and a full-scale lockdown."

  • He turned out to be wrong that such a regime would be a necessary precondition for economic recovery. Instead, the U.S. made its peace with 544,000 deaths and counting.

The bottom line: Thanks to expansive fiscal and monetary policy, the economic contraction didn't become a financial crisis. Indeed, markets became part of the engine bringing the economy back to life.

  • The true calamity was not economic, but rather humanitarian: an average of roughly 1,500 Americans dying of COVID-19 every day for the past year.
4. When a housing bubble is dangerous
U.S. data: Federal Housing Finance Agency, Federal Reserve Board; Canada data: Statistics Canada, Equifax Canada; Chart: Andrew Witherspoon/Axios

Rising home prices are causing concern around the world, from Canada to New Zealand. Everybody needs shelter, so it's incumbent upon governments to keep it affordable.

Why it matters: A housing bubble raises the specter of a catastrophic housing bust like we saw in 2008.

Be smart: When home prices run ahead of mortgage debt, like we're seeing in the U.S., that's a good sign. It shows that homebuyers aren't extending themselves too much, and that the amount of home equity in the country — roughly, the amount that prices could fall without causing major pain — is also going up.

  • In Canada, by contrast, mortgage debt is outpacing house prices. That's much more dangerous, especially given the Canadian banking system already has twice as much exposure to home loans as American banks do.
5. How to make poorer Americans richer

Illustration: Aïda Amer/Axios

If you're happy with your retirement plan, there's a very good chance you're a federal employee. Now there's a bipartisan proposal to extend that excellent service to the people who need it most — middle- and low-income households who don't have any retirement savings at all.

Why it matters: The federal government currently spends about $250 billion per year on tax incentives for richer Americans to pay into 401(k) accounts and IRAs. The new proposal, from the Economic Innovation Group think tank, would add about $50 billion more to help most of the bottom 50% of the population.

How it works: Some 6 million federal employees, including members of Congress, pay into the Thrift Savings Plan (TSP) — the largest defined-contribution pension plan in the world.

  • The TSP is a huge success, boasting an incredibly low expense ratio of about 0.04% as well as a 95% participation rate for employees with a high school degree or less.
  • The scheme proves, says EIG CEO John Lettieri, that "if you give low-income workers access to a well-designed retirement plan, they will participate. If we didn't have TSP, we couldn’t say that."

The public policy organization's new proposal, from right-wing economist Kevin Hassett and left-wing economist Teresa Ghilarducci, would effectively give all low-income Americans the same retirement-savings opportunities that are currently extended to federal employees.

6. The first-ever NFT

Illustration: Eniola Odetunde/Axios

The first-ever NFT was minted by artist Kevin McCoy in 2014 — you can see his presentation with technologist Anil Dash here.

Why it matters: While NFTs are regularly talked about as "digital art," few if any of them have much in the way of serious art world credentials.

  • McCoy is an exception. With his wife Jennifer, he has established himself over many years as a first-rate digital artist. One of their works is on display now at the Metropolitan Museum of Art.
  • "The NFT phenomenon is deeply a part of the art world," says McCoy. "It emerged from the long history of artists engaging with creative technology."

The first NFT, "Quantum," which can be found here, has the kind of historical importance that is sometimes ascribed to CryptoPunks; it's therefore of interest to crypto investors and other NFT-collecting technologists.

  • The McCoys' work has historically been collected by art collectors, however — the kind of people who deal in genteel transactions with a gallery, rather than entering into public bidding wars.

"Quantum" is for sale, if you have $7 million or more to spend on it. What's not clear is exactly how it will be sold. Says Tamas Banovich, McCoy's gallerist at Postmasters gallery in New York: "We are trying to figure out which world is appropriate."

7. Crypto catastrophe bonds

Illustration: Eniola Odetunde/Axios

The crypto world likes to support good causes — Jack Dorsey's first tweet sold for $2.9 million this week, while a Beeple sold for $6 million, with the proceeds from both sales going to charity. Now the Danish Red Cross is trying to use blockchain technology to actually build charitable capacity.

How it works: The Danish Red Cross has issued a cat bond — a bond that pays a regular coupon, but doesn't repay the principal amount in the event that a pre-defined catastrophe occurs.

  • In return for 5% coupon payments, being paid with money from the Danish foreign ministry, investors in the bonds will lose their entire initial investment if one of a specified 10 volcanoes erupts in a way that's likely to cause a humanitarian crisis.
  • The money will immediately be freed up and transferred to local aid agencies — even before the plume from the volcano has had time to start causing real damage.

What's new: This bond, at just $3 million, is much smaller than most cat bonds — in fact, it's so small that the up-front costs of creating such a bond would normally make this uneconomic. (Most such bonds cost about $1 million to issue.)

  • This bond is issued and traded on the blockchain, however. Cedric Edmonds, the founder of Replexus, the company behind the technology, says that alone saves some $400,000.
  • The Danish Red Cross hopes to upsize this bond issue to $10 million, when it finds further donors to cover the coupon payments. That, too, is much easier on the blockchain than it would be traditionally.

The bottom line: Most charitable donors don't want to see their money used on coupon payments for bond investors. But some do! A $50,000 coupon this year could mean $1 million going to a needy community if disaster strikes.

8. Coming up: The end of the SLR exemption

Illustration: Aïda Amer/Axios

Wednesday is the last day that banks will be able to ignore their Treasury bond holdings and central bank reserves when they're calculating their supplementary leverage ratio, or SLR.

Why it matters: First, congratulations, you kept on reading after a sentence designed to put 99% of the planet to sleep. But also, this really matters!

  • The SLR is a way of measuring how leveraged a bank is. For the past year, as part of the Fed's pandemic response, the Fed has allowed banks to report artificially low leverage, by ignoring certain risk-free assets. That exemption comes to an end on Wednesday.
  • The result is that America's biggest banks will be more hesitant to accept large corporate deposits, and might also be more constrained in terms of their ability to do stock buybacks.
  • The worst-case scenario — an unlikely one — is that banks will leave the Treasury market, causing another bout of liquidity problems.
9. Building of the week: Children's Mercy Research Institute

Photo: Matt Kocourek Photography

Children's Mercy Research Institute is a brand-new, 375,000-square-foot pediatric hospital in Kansas City, designed by Jackie Foy of BSA LifeStructures.

  • The colored vertical strips on the windows encode four newly-discovered genetic variants that cause rare disease in children.