Mar 7, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • The Fed plans to end bank stress test grades and ease scrutiny on big financial institutions, asset managers and insurance companies, rolling back policies set up after the financial crisis. (WSJ)
  • Huawei said it has filed a federal lawsuit against the U.S. government, challenging a law that keeps it from selling its telecommunications gear here. (Axios)
  • The new health care venture announced by Amazon, Berkshire Hathaway and JPMorgan Chase will be called Haven. (Bloomberg)
  • SoftBank is launching a $5 billion fund to invest in tech startups in Latin America, headed by ex-Sprint CEO (and current Softbank COO) Marcelo Claure. (WSJ)
1 big thing: Facebook's next move

Illustration: Aïda Amer/Axios

Yesterday's privacy announcement from Facebook CEO Mark Zuckerberg has been framed as a response to public outcry about the company's lax data privacy standards, but it's really about Facebook going all in on what it sees as the future of communication, payments and life.

Why it matters: Facebook's move from a desktop social network to mobile communication hub was Facebook 2.0 and it made the company one of the most profitable in the world.

Facebook's next move is about expanding the power of the phone for every aspect of a user's life. It's the company's attempt to replicate and expand the WeChat model that exists in China.

  • As Shannon Liao wrote for The Verge last year, WeChat is not just a platform where people talk to friends, it's where they "play video games, pay bills, find restaurants, book doctor appointments, file police reports, hail taxis, hold video conferences and access banking services. State-run media and government agencies also have official WeChat accounts, where they can directly communicate with users."

The big picture: Facebook has been laying the infrastructure for a similar project for years.

  • While U.S. shareholders were arguing over whether the company's North American daily active user numbers justified its stock price, Zuckerberg was building a global userbase that relies on Facebook for internet access.

In many developing countries Facebook is the internet. It has been working with local internet service providers to offer what it calls Free Basics, which let people use Facebook and other apps that come installed on their phones for free. It has set up shop in countries throughout Asia and Africa.

Be smart: Facebook is losing users and its "cool factor" in North America where it derives much of its current revenue, but its acquisitions of WhatsApp and Instagram have built a global ecosystem of 2.3 billion people.

What's next? The new "Facebook coin," even if not quickly adopted by payment processors, can become a global currency that users of Facebook, WhatsApp and Instagram can use to complete transactions among themselves anywhere in the world.

  • The inspiration here also comes from China, where cash is essentially a thing of the past. Even with merchants on the street, customers use Alibaba's mobile payment processor Alipay and Tencent's WeChat Pay to buy everything.

Both platforms individually handled more payments in a single month in 2017 than PayPal's $451 billion for that entire year, according to research firm Analysys. In 2017, mobile payments totaled $32 trillion, according to the People's Bank of China.

  • With that kind of scale and access to user data (which will deepen substantially with tracking of users' bank accounts and spending habits in addition to their phone records, messaging history, location and searches) it's not hard to imagine companies won't pay up to accept and get a piece of Facebook coin — to say nothing of advertising.

Yes, but: There's no guarantee this all works out for Facebook. The Cambridge Analytica scandal showed Americans are averse to at least some level of privacy invasion and whereas the Chinese government is basically a partner in WeChat, the U.S. government may prove more of an adversary for Facebook.

Bonus: Can they do it again?
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Data: FactSet, Yahoo Finance; Chart: Andrew Witherspoon/Axios

Since it debuted in May 2012, Facebook has been one of the best performing stocks in the world, far outpacing returns for the broader S&P 500. However, in 2018 that changed dramatically.

CEO Mark Zuckerberg is betting that the shift to micropayments and private, encrypted messaging of Facebook 3.0 gets the company back to its winning ways much the way the pivot to mobile turned the company's fortunes around after a difficult period following its IPO.

Go deeper: Facebook's pivot is bigger than privacy

2. No covenant, no problem
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Data: LCD, S&P Global Market Intelligence; Chart: Andrew Witherspoon/Axios

The weakening credit quality in loans continues and is even picking up steam, data from S&P Global shows.

Why it matters: So-called covenant-lite loans account for nearly all leveraged loans originated in Europe so far this year and 85% of those issued in the U.S. in 2018.

  • The loan structures were largely unheard of prior to 2010, being used in just 5% of U.S. loan originations, and not used in Europe at all until 2012.

What it means: The loans are called covenant-lite because they lack traditional loan requirements and offer less protection for lenders and investors than traditionally structured credits if borrowers default.

  • "To me it's a late cycle indicator," said David Lebovitz, Global Market Strategist at JPMorgan Wednesday. "If you are a borrower and you are able to walk in and dictate the terms of your loan, basically have very few protections for the lender, you have to be in a pretty tight environment."

The loans are typically not held on bank balance sheets, helping the banks look healthier and less risky. However, the banks are largely just passing those risks on to asset managers and private equity firms.

The big picture: Not only are covenant-lite loans growing in the share of new loans issued, as of February their share of all outstanding leveraged loans reached 82% in Europe and 79% in the U.S. There is currently $928 billion of covenant-lite debt outstanding in the U.S. and 148 million euros worth in Europe.

  • "As a borrower, it's a great time. We don't need covenants on anything anymore. We want to buy a building, build a building, we can borrow as much as we want at the terms we want. It's great. The last thing I want is to be the guy who provides that funding on the other side," said JPMorgan Global Alternatives Managing Partner Anton Pil. "This will end poorly. It's just a question of when."
3. Low growth, large balance sheets

Ahead of today's European Central Bank meeting, Marvin Loh, Global Macro Strategist at State Street Global Markets, spoke with Axios about the seeming contradiction he's been hearing from central bankers. Policymakers consistently say the economy is strong or improving, but they still need to purchase hundreds of billions of dollars a month in securities.

"That's the question that's not being asked or spoken about enough. What does it mean when these multi-trillion dollar balance sheets, not only in the U.S. but also in Europe, can't even get close to pre-crisis levels without causing market volatility?
"It means that there's a certain degree of monetization of debt and the market and economies are reliant on these central banks maintaining very, very large balance sheets.
"If we think about what that means from a growth perspective … we wind up in this new normal type of environment where we've got low growth, large balance sheets that are needed to support the newer growth profile and an environment where we're monetizing a larger and larger component of the debt that's issued by various governments.
"When you've got lower growth, financial markets generally aren't going to grow that much. They're going to grow at the rate of your GDP growth and your population growth. But with population growth really slowing down, you've got these central banks that are running larger balance sheets, holding a larger portion of the financial assets and to a certain degree supporting financial markets."
— Marvin Loh, Global Macro Strategist at State Street Global Markets in a phone conversation
4. A step back for dollar stores

Some 4 years ago, 2 discount retail kings — Dollar Tree and Dollar General — were fighting over who would absorb the third dollar store giant, Family Dollar. Dollar Tree won out.

But today, lagging sales at Family Dollar are actually dragging Dollar Tree down, reports the Wall Street Journal.

As we've reported, discounters have long profited from the rise of income inequality in the U.S. And with a recession likely in the near future, the dollar store business will keep ballooning, Louis Hyman, a business historian at Cornell, tells Axios' Erica Pandey.

  • Still, Family Dollar has not been able to keep up. While Dollar Tree and Dollar General are sprucing up their shops and adding fresh produce options to lure customers, Family Dollar remains shabby.
  • Since Dollar Tree acquired the chain, its stock price has surged by 20% — a formidable jump but small compared to Dollar General's 50% increase in the same time period.
  • To tackle the gap, Dollar Tree is shuttering 400 Family Dollar stores and turning another 200 into Dollar Trees after renovations.

For Dollar Tree, which owns 15,000 stores across the country, that's a drop in the bucket. But, to add context, 400 stores is almost equal to the total of the Whole Foods chain.

5. The Fed's beige book in a tweet
Screenshot from Ivan the K's Twitter feed

The Fed's Beige Book released yesterday showed activity growing at slight-to-moderate pace in 10 of 12 districts. Philadelphia and St. Louis were flat. But analysts noted the report was less optimistic than reports last year, in line with weaker recent manufacturing surveys.

However, manufacturing activity continued to strengthen despite "concerns about weakening global demand, higher costs due to tariffs, and ongoing trade policy uncertainty."

Additionally, several districts emphasized input prices rising faster than sales.

Dion Rabouin

Editor's note: In yesterday's Markets, the data source listed for the Bonus chart was corrected to say Compustat & Haver via Deutsche Bank (not the Atlanta Fed).