Laughing So Hard It Hertz

Hertz, the Superstar in Rent-a-Car, filed for bankruptcy on May 22nd. That’s when the fun began. Hertz stock, henceforth to be known as HTZ, fell to 56 cents on May 26th, the business day after its Chapter 11 filing. Then, HTZ ascended like Icarus. It hit a high of 6.25 and closed at 5.53 on June 8th. Shortly thereafter I wrote about it in The Spin, my newsletter. (If you don’t subscribe, you are missing out.) I talked about HTZ bond prices, the bonds’ senior claim to the equity in bankruptcy and the likelihood that HTZ stock was worthless. I thought I was done, but no. It got better.

HTX061720The HTZ debtors, who now control the company, took note of the reanimation of the firm’s equity. They went before the bankruptcy judge and asked permission to sell about 247 million shares of common stock in the bankrupt company. This is chutzpah! (For those who don’t know, chutzpah is nerve, brass balls level nerve. The classic example is someone who murdered their parents asking the court for leniency because they’re an orphan.) The thing about chutzpah is that it works! The judge agreed.

Neither I nor anyone else can hark back to a sale of equity by a bankrupt company. Why would we? The equity value of bankrupt companies is almost always zero. That is no different in this case. If the equity is to have any value, the bonds must be paid off in full. That is the way bankruptcy works, at least in the US. In some other countries, making similar assumptions about the priority of claims might not be a good idea. Trust me, I know.

If you ever think about getting involved in the stock of a problematic company like HTZ, you need to:

  1. Get a sense of the capital structure. Equity is lowest on the totem pole. What stands ahead of you?
  2. Find out where the bonds, if any, are trading. Price information is the gold standard. It tells you a huge amount about what is really going on. Distressed bond investors do their homework, unlike many equity “investors”.

Don’t be this guy:


Leaving his grammatical error aside, our Canadian friend is citing someone who pulled their argument from a place where the sun don’t shine. HTZ’s car fleet is pledged, a fancy pants way of saying that the cars are collateral for asset backed securities (ABS). It gets better. The cars collateralizing the ABS  dropped in value due to the lack of travel during the pandemic. That triggered what was effectively a margin call. The company needed to hand over more dough to the ABS investors to maintain the value of the collateral.  Hmm, no revenue. Better file.

It’s the day traders who bought a bankrupt stock who are about to get run over.

HTZ debt structue

Source: FT Alphaville

Now, consider the following statement from Moody’s, the credit rating agency:

The C rated unsecured domestic obligations reflects a recovery rate that could be below 35% after first- and second-lien claims are settled. 

The above mentioned C rated securities are HTZ’s senior notes. Despite their “Senior” designation, they are just ahead of  the caboose, i.e., the equity. Moody’s thinks they’re worth 35 cents on the dollar. If Moody’s is right, the $2.7 billion in senior notes are worth $945 million, leaving at least $1.755 billion to be made up before the stock holders see a dime. I say “at least” because there are loans and secured bonds in line ahead of the senior notes.

I am sad to report that the stock sale was suspended on June 18th. The SEC, in its wisdom, has decided that they have issues with the disclosures.

Apparently, this

“Although we cannot predict how our common stock will be treated under a plan, we expect that common stock holders would not receive a recovery through any plan unless the holders of more senior claims and interests, such as secured and unsecured indebtedness (which is currently trading at a significant discount), are paid in full, which would require a significant and rapid and currently unanticipated improvement in business conditions to pre-COVID-19 or close to pre-COVID-19 levels,” the filing said.

and this

“There is a significant risk that the holders of our common stock, including purchasers in this offering, will receive no recovery under the Chapter 11 cases and that our common stock will be worthless.”

are not clear enough.

Disclosures: We Are One Seven, LLC d/b/a: Park City Family Office. This document may contain forward-looking statements relating to the future performance of the market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “estimated,” “potential” and other similar terms. Forward looking statements are subject to various factors, including, but not limited to economic conditions, changing levels of competition and markets, changes in interest rates, that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, and uncertainties. Actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements. None of One Seven or any of its affiliates or principals nor any other individual or entity assumes any obligation to update forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.
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Puzzling Over Equity

As the Chief Investment Strategist, I am responsible for determining our firm’s stance with regard to the equity markets. This does not mean that I predict where the stock market is going. That is a fruitless task, despite what you might hear on TV or see on your Twitter feed. Instead, I try to think probabilistically about the markets. I weigh the evidence. I ask whether it makes sense that current drivers continue to dictate market outcomes. I am not dogmatic. Markets change. What works in one era may not work in the next.

I am pondering where we go from here. The stock market did very well since it bottomed eleven years ago. It was a great run. It was characterized by the fact that just three sectors carried the burden of the bull market on their backs. Two of the three were growth oriented, technology and consumer discretionary. Healthcare, the third, falls into the “Blend” category, neither fish nor fowl, not growth, nor value. Value as an investing strategy was left in the dust. So too were small stocks, international stocks and emerging markets. It was just the US and within the US it was growth.


XLV=Healthcare. XLK=Tech. XLY=Consumer Discretionary. SPY =S&P 500.

Continue reading

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A Short Sharp Shock?

These fevered times bring back memories. We have not seen such sudden wrenching change in the economy from an external shock since the 1970s / early 1980s. Since then, slowdowns and market disruptions have been financial: the S&L crisis, the European exchange rate mechanism collapse, the Mexican devaluation, the Asia crisis and Russian default, the tech wreck, and, finally, the global financial crisis. We had been spared supply shocks and their sudden disruptions until now.

Along with the oil shocks of that era, this reminds me of another, little remembered, shock, the imposition of credit controls by Jimmy Carter. Those controls, while mild in and of themselves, had a disproportionately negative effect on the economy. Here we have a twofer, the coronavirus is affecting both manufacturing via supply chains and services through announcement effects and fear.

Manufacturing is usually the swing factor in an economic cycle. It is far more volatile than services, many of which are central to our everyday lives. We simply cannot or will not live without them. Diminished demand typically drags down manufacturing. Not this time. The coronavirus or COVID-19 has been affecting manufacturing by disrupting supply chains. iPhone components are not being manufactured and vessels are not sailing.


Manufacturing is more volatile than services. Source: Bureau of Economic Analysis

The virus is affecting and will further affect services, which account for seventy percent of activity in the United States.  Services typically undergird the economy even through downturns, are far less cyclical than manufacturing and are less prone to turning negative. The times they did go negative were in the 1970s and 1980s and again in the wake of the Global Financial Crisis (GFC). The earlier period featured two oil shocks, the high interest rates of the Volcker era and the Carter credit controls. Those credit controls consisted of a “voluntary” cap on loan expansion combined with a fifteen percent deposit against certain types of credit. They hit credit card spending hard, less through their direct effects than from the announcement of the program. Consumer spending plunged. People sent cut up credit cards to the White House and berated issuers who still solicited credit card accounts as unpatriotic.


Services don’t go negative very often, but supply shocks have sent them there. Source: Bureau of Economic Analysis

COVID-19, while a real and present danger to our health, is similar to Carter’s credit controls; the dissemination of information about the virus has led to profound effects on travel and other consumer services. It is bringing a series of sudden stops to areas of the economy that are not used to this kind of disruption. Yes, we saw sharp declines in travel after 9/11, but not the unwillingness to assemble or to venture out locally. Some of these strictures are involuntary. A doctor friend has been told by his employer not to be in a group larger than five and my wife’s company is conducting meetings for people who are on premises via Skype.

While COVID-19 is having a real effect on the world economy and on our personal lives, don’t despair. This could be over relatively quickly if the authorities react appropriately and are able to contain it. If the health emergency continues for an extended period, I see a potential risk to highly indebted firms whose cash flow suffers. Such firms will need guaranteed access to bridge financing, rather than the cut in rates the Fed provided. I hope that does not come to pass, but there it is, forbearance, not price, is what I expect will matter.

As for me, I am involuntarily quarantined, having broken my ankle in a mountain biking accident. A blessing in disguise? Who knows?

In the words of Sgt. Phil Esterhaus: “Let’s be careful out there.”

Disclosures: We Are One Seven, LLC d/b/a: One Seven. This document may contain forward-looking statements relating to the future performance of the market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “estimated,” “potential” and other similar terms. Forward looking statements are subject to various factors, including, but not limited to economic conditions, changing levels of competition and markets, changes in interest rates, that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, and uncertainties. Actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements. None of One Seven or any of its affiliates or principals nor any other individual or entity assumes any obligation to update forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.


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We Need to Talk About the Yield Curve

What is the yield curve and why should I care? The yield curve is a graph of the yields that government bonds are paying, arranged in order of time to maturity. You should care because the cost of mortgages, bank loans, student loans, corporate bond yields, etc., are all set with reference to various government yields. Another reason you should care is that the yield curve can (seemingly) predict the future.¹ It has predicted all seven recessions since the late 1960s. Yes, you read that right. All seven. It did make one bad call back in the mid-60s, so it’s not infallible. If its record continues, there is a chance of a recession sometime either side of Election Day 2020.  Take a deep breath. A recession is not guaranteed. It’s just a possibility we should consider, given the yield curve’s track record.


Note that short term rates are higher than many longer term rates.

The curve’s predictive power shows itself through what is called an inversion. The curve is inverted when a short term yield is higher than a long term yield. The usual state of things is that longer term bonds yield more than shorter term bonds.

The Federal Reserve’s preferred measure for whether the yield curve is upward sloping or inverted is the relationship between three month bills and ten year notes (3m10y). That is the one I’m going to talk about. Many market commentators prefer the difference between the two year note and the ten year. It’s a free country. Continue reading

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It’s Time For Predictions; I Don’t Play That

Here we are at the start of a new year and a new decade. Is it really a new decade? Personally, I’m the sort who starts counting at one, not zero, but I’ll go along and say it is a new decade. This sort of thing compels people to predict the unpredictable. Why? (Insert emoji of guy shrugging shoulders and throwing up hands.) I don’t believe in prediction and don’t do it, at least not in public. I do, however, believe in observation and probability. In this spirit, I think we need to talk about the US stock market.

The US stock market had a great ten years. The S&P 500’s (SPX) total return, the one including dividends, averaged 13.56% a year.  Its cumulative return was 256.7%. This was a great run. In fact, it was such a good run that you would have been better off ignoring all the advice about international diversification and just put all your chips on red, white and blue. Any part of your equity allocation devoted to the rest of the world would have earned just 52.4% for the decade or a paltry 4.3% per year.


The US trounced the world in the teens

Back to the part wherein I mentioned that I believe in probability. Adam Butler of ReSolve Asset Management put together this chart showing the actual performance of the SPX over the last decade versus 10,000 simulated performances of the SPX. He used the SPX’s own randomized historical excess return data from 1900 to the present for the simulated returns.


Note that the last decade’s performance is pressing up near the top of the cone. That point represents the 95th percentile of wealth that would have been created under all the scenarios run. Sort of like catching the perfect wave. There is only a 6% probability that this recurs. As a betting man, this is a bet that I recommend fading.

It was not so long ago that US and foreign returns looked like this:


Foreign markets beat the US from 1999-2009

And if the historical record is any indication, performance like we just saw in the teens is not typically followed by similar performance.


So spread your wings and diversify. There’s a chance that this will be the wrong course of action, but the probabilities say otherwise. There’s also a chance that Tom Brady remains at the helm of the Patriots and stays as effective for the next ten years as he was for the last ten years. I just wouldn’t bet that way.


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Fire and Ice

Some say the world will end in fire,
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire.
But if it had to perish twice,
I think I know enough of hate
To say that for destruction ice
Is also great
And would suffice.
– Robert Frost

On October 6, 1979 Paul Volcker declared war on inflation. It took several years, two recessions and a Fed funds peak of 22.4% before he won. History says that Volcker did the right thing. There were plenty of doubters at the time. I was not one of them. Perhaps I was biased, because I worked at the NY Fed. Still I had no doubt that Volcker was doing the right thing by using monetary policy to stamp out the fire of runaway inflation.


They knew how to tighten back in the day.

Today, central bankers have cut rates to the lowest levels in history. Much of the world’s government debt has negative yields. Lenders are paying borrowers; the world has turned upside down. You can, if you would like, lend Germany money today at -0.35% a year for 10 years.

Unlike forty years ago, I have my doubts. I don’t think monetary policy can free economies locked in ice. Continue reading

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Coping with a No-SALT Diet

As of 2018, we have been forced onto a SALT free diet. Where once my wife and I were able to deduct state and local taxes on our federal return, we no longer can. We are limited to a $10,000 deduction for SALT. This doesn’t even begin to cover our formerly deductible property taxes and state income taxes. Small compensation it is, but enter the 529 plan.

The 529 allowed us to save for our children’s education by contributing to an account whose gains and income accrued tax free. Upon redemption, we were able to pay educational and related expenses without triggering a tax bill. This was a great deal.  Unfortunately, we exhausted our children’s accounts in paying for college. So what do you do if you still have to or want to help your children as they continue their education?

We have had one child go to business school and another about to enter law school. We don’t want to expose our contributions to market risk. They are going to be withdrawn to pay tuition tomorrow. So, why bother with the 529? Tax deductions!

You can contribute the funds and withdraw them almost immediately, effectively using the 529 as a pass through. This qualifies you for the state tax deduction while avoiding market exposure. It’s still a low SALT diet, but it’s better than nothing. There is no federal deduction for 529 contributions, but many states allow for it. A $10,000 joint contribution in New York, where we live, is worth over $650 to most couples and half that to individuals. Speaking of individuals, our children, who worked prior to attending grad school, have made tax deductible contributions for themselves.

While 529 plans are close to an unalloyed good, the contribution strategy only works in states that allow you to deduct plan contributions from your state income tax. As with pumping your own gas, this doesn’t work in New Jersey. Suffice to say that you should talk with your advisor, as your state’s laws and tax treatment of this may differ.


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Diversification’s Gold Standard

I am an advisor with a past, a past managing global bond funds. For over twenty years, I invested in a vast array of markets and bond sectors around the globe. These included sectors like high yield and emerging markets that could be as volatile as equities. Did I mention that there were multiple currency exposures too? As I did this I learned to insure against the possibility that the world wasn’t always going to turn out the way I thought it would. This often meant holding assets like government bonds of longer duration than most individuals might find comfortable. Why? Because long duration means high interest rate sensitivity and that is what you need when the world turns upside down. Sometimes other assets can play this role, but not always in a reliable fashion.

In order for an asset to act as an effective counterweight to the riskier parts of your portfolio it should zig when they zag. Continue reading

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Man Plans, and God Laughs.

Der mentsh trakht un got lakht.  — Yiddish proverb

Winston Churchill believed that he had limited time. His father, Lord Randolph Churchill, had died just shy of his 46th birthday. Sir Winston lived into his 91st year, smoking cigars and drinking multiple glasses of whisky and soda, champagne and wine every day. Similarly, my father lived into his 91st year after having smoked for about 65 of those years. His sister, my beloved Aunt, died at the age of 61 from emphysema, never having smoked in her life. You just do not know what cards you’ve been dealt until the dealer turns them over. How do you handle the uncertainty? Plan, while making an effort to live now.

People are, on average, living longer. It can be a blessing, but it is a risk too. Coping with it may require changes in your savings and spending rates, your investment policy, what you insure against as you age and the habits that affect your health. So it makes sense to plan and to adapt. We can talk about those things if you would like. Feel free to get in touch; it’s what I do, but right here, right now, I would like to talk about embracing the things you would like to do while you are able to do them.

While it makes sense to plan as if your outcome is going to be similar to Sir Winston’s or my father’s, hedge by living life to the fullest in case you don’t have their genes or their luck. You probably don’t want to emulate their habits, but total risk aversion in your personal life may not be all that fulfilling either. I’m not opposed to risk; I took up mountain biking in my fifties and I still ski the steepest bumpiest runs that I can. And, at the extreme, I get Grandpa’s take on snorting heroin in Little Miss Sunshine, though copying him would be a bridge too far…at least for me. Continue reading

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Does/Should the Fed Care About the Stock Market?

Once upon a time, in another millennium, I worked at the Federal Reserve Bank of New York. It was during the reign of Chairman Volcker, first of his name. One thing I did was prepare statistical packages for the officers to use in the run-up to the FOMC meeting. The tables and charts covered inflation measures, the non-financial economy, interest rates and exchange rates.  Perhaps it was a simpler time or just a different time, but the stock market was barely, if ever, mentioned during my tenure. From the reign of Maestro Greenspan down through the present day, it has become an article of faith among stock market commentators that the Fed reacts to the equity market. Is this true? Should it be true?

The Fed’s objectives were established by Congress in The Federal Reserve Act in 1977. They are maximum employment, stable prices, and moderate long-term interest rates. This is called the “Dual Mandate”. It focuses on the real (non-financial) economy.


Source: Federal Reserve Bank of Chicago as of 6/12/19

  • Stable prices has been defined as a core inflation rate of around 2%. Inflation means changes in the overall price level of goods and services. Asset price inflation, or the perceived overvaluation of financial markets, is not a policy target.
  • Maximum employment is defined as getting to an unemployment rate that will not cause inflation to accelerate. Unemployment, beyond that amount, results from the economy running below its capacity. The current unemployment rate, despite being below the Fed’s estimate of the appropriate rate, is not a cause for concern. Inflation is below its target too.
  • Moderate long-term interest rates get no attention as a policy target. Perhaps because they should result if the first two goals are fulfilled.

Note that the stock market doesn’t get a mention, not even a footnote. Continue reading

Posted in Credit, Economics, Equities, Investing, The Fed | Tagged , , , | 2 Comments