Friday, June 23, 2017

The Bezos and Buffett Effect?

Matthew Boesler of Bloomberg reports, Amazon Has at Least One Fed Official Rethinking Inflation:
News that rocked the retail world last week is coming at just the wrong time for U.S. central bankers already puzzling over why inflation is conspicuously absent.

When online retail giant Inc. announced last Friday that it would purchase Whole Foods Market Inc., a plunge in retail and grocery stocks reinforced the disinflationary tone set by three straight months of disappointing data on consumer prices. It’s an example of the technological forces that are increasing competition and further limiting companies’ ability to pass on higher wage costs to customers.

“That normally indicates that somebody thinks that they are not going to be earning as much as they were,” Federal Reserve Bank of Chicago President Charles Evans said of the market reaction to the deal while speaking with reporters Monday evening after a speech in New York.

“For me, it just seems like technology keeps moving, it’s disruptive, and it’s showing up in places where -- probably nobody thought too much three years ago about Amazon merging with Whole Foods,” he said.

Evans, a voter on the Federal Open Market Committee this year who supported its decision to raise interest rates last week, says he is less confident than most of his colleagues that inflation will soon rise to their 2 percent target.

A big reason for his ambivalence: Deflationary competitive pressures could have become more important for the overall trend in prices than the so-called Phillips Curve relationship, which links inflation to the state of the labor market. That model, coined almost 60 years ago, is the basis for the Fed’s outlook for continued gradual rate increases.

In order for it to work, though, businesses need to be able to raise prices to offset increases in labor costs as unemployment falls and available workers become more scarce. But a stumble in corporate profit margins suggests companies are struggling to raise prices.

“That’s one of the things that makes me nervous, that I think there’s something possibly going on, some secular trend, that isn’t just a U.S. story,” Evans said.

“We know that technology is disruptive. It’s changing a number of business models that used to be very successful, and you have to wonder if certain economic actors can continue to maintain their price margins, or if they are under threat from additional competition,” he said. “And that could be an undercurrent for holding back inflation.”

Every indication from FOMC leadership is that continued tightening in the labor market will lead to higher inflation, despite the recent wobbles in the inflation data, which Fed Chair Janet Yellen called “noisy” in a press conference following last week’s meeting.

“We think if the labor market continues to tighten, wages will gradually pick up, and with that, we’ll see inflation get back to 2 percent,” William Dudley, who as New York Fed president is also vice chairman of the FOMC, said Monday in Plattsburgh, New York.

Such remarks reinforce expectations that policy makers will hike again before the end of the year, as signaled by their latest forecasts for interest rates.

Evans isn’t ready to abandon that logic yet, either, but he does sound more skeptical.

“I can’t say that the Phillips Curve isn’t going to lead to higher inflation, but I worry that it’s very flat and it’s not going to,” he told reporters Monday. “It’s still very early in this process.”

The Chicago Fed chief is not alone in thinking about the impact of disruptive technologies on prices. Dallas Fed President Robert Kaplan -- another FOMC voter this year -- describes such forces, and the uncertainty they generate, as currently the most intense he’s ever seen.

Ultimately, if the unemployment rate continues to fall and inflation doesn’t respond, the Phillips Curve may fall further out of favor as a guide to inflation dynamics, and by extension, interest-rate policy, as Evans hinted at Tuesday in a follow-up interview on CNBC.

“If that’s the case -- and I think that’s just speculative at this point -- then it means we need even more accommodation to get inflation up,” he said.
You can read Federal Reserve Bank of Chicago President Charles Evans's speech here. Take the time to read through this speech, it's excellent.

Last Friday, I discussed whether the Fed is making a huge mistake tightening as the US economy slows. I went over a comment written Minneapolis Fed President Neel Kashkari explaining why he dissented again.

In that comment, I stated the following:
I've been warning of the risks of debt deflation for a very long time, long before I began writing this blog in 2008 right before the financial crisis hit full force.

In a recent comment of mine where I discussed why Citadel's Ken Griffin is warning of inflation, I went over yet again six structural factors that lead me to believe we are headed for a prolonged period of debt deflation:
  • The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits.
  • Demographic time bomb: A rapidly aging population means a lot more older people with little savings spending less.
  • The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
  • Excessive private and public debt: Rising government debt levels and consumer debt levels are constraining public finances and consumer spending.
  • Rising inequality: Hedge fund gurus cannot appreciate this because they live in an alternate universe, but widespread and rising inequality, is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time.
  • Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics,  and other technological shifts that lower prices and destroy more jobs than they create.
Now, we can argue about the importance of each structural factor but there is no arguing that an aging population, a less-than-spectacular labor market, the global pension crisis, excessive public and private debt, rising inequality and technological shifts are all deflationary.

All this to say that I agree with Neel Kashkari, I think it's silly for the Fed to raise rates in a deflationary environment, especially now that the US economy is slowing. Not surprisingly, institutional investors are "increasingly uncomfortable" with the Fed tightening during a slowdown.
I don't just think it's silly for the Fed to raise in a deflationary environment, I'm equally perplexed when I read comments on why the Bank of Canada is all of sudden in a hurry to raise rates. On LinkedIn, I posted this comment regarding this article:
"I think it is highly unlikely the Bank of Canada will hike in July if oil prices keep dropping from now till the meeting. If the BoC hikes, it will only exacerbate deflationary pressures. The only rational argument I've heard for hiking is to cool speculative activity in the housing market, but the market is already taking care of that. Having worked with Steve Poloz at BCA Research a long time ago, he might like to suprise people once in a while, but he's no cowboy and is well aware of the deflationary risks I'm talking about."
Speaking of BCA Research, I agree with Anastasios Avgeriou, BCA's Chief Equity Strategist, no matter what Pimco's Ivascyn says, this time isn't different, the inverted yield curve is signalling a US recession ahead:

I warned my blog readers in April that the next economic shoe is dropping and more recently to prepare for a US slowdown

The US slowdown is already underway and next will follow Europe, Japan, China and the rest of the world. This is why I remain long US long bonds (TLT), the US dollar (UUP) and select US equity sectors like biotech (XBI) and technology (XLK) and I'm underweight/ short energy (XLE), materials (XME), industrials (XLI), financials (XLF) and emerging markets (EEM).

In fact, had you loaded up on biotech (XBI) prior to the US presidential election back in November when I wrote about America's Brexit or biotech moment and loaded up on US long bonds (TLT) at the start of the year when I explained why it's not the beginning of the end for bonds, you would have made great returns and thrown me a bone via a donation or subscription to this blog (I remain long biotech but took some profits and added to my US long bonds).

Anyway, I'm talking up my book and getting off track. Back to the Bezos or Amazon effect. I was talking to a buddy of mine earlier this week about Amazon's impact on inflation. He mentioned to me "it's like the Wal Mart effect that happened in the 90s but on a much bigger scale and much more pervasive."

I agree, Amazon has forever changed the retail landscape which is why many retail stocks (XRT) have gotten killed over the last year (click on image) :

Now, before you go buying the dip on retail stocks, let me show you a scarier chart that goes back over ten years (click on image):

I'm not saying we are going to revisit the 2008 financial crisis levels but I would be very cautious on retail stocks. In fact, if you want retail exposure, you're probably better off sticking with Amazon (AMZN), the online retail goliath that has been growing by leaps and bounds over the last ten years, succeeding in online shopping and its cloud business (click on image):

Still, I think it's best to temper your enthusiasm on any retail stock, including red-hot Amazon as we head into a US and global recession.

Also, following Amazon's Whole Foods deal, I saw some grocery stocks like Kroger (KR) get killed as if it's a done deal (it's not) and as if grocery stores will never be able to compete against Amazon (click on image):

Kroger's stock is way oversold (resting on its 400-week moving average) and although I'm not particularly bullish on it, I think this is a gross overreaction and if a recession hits, you want to have defensive stocks like grocers in your portfolio.

Anyway, there is little doubt Amazon has an impact on inflation just like Uber, Nexflix (NFLX) and Tesla (TSLA) do. In fact, my buddy shared this me earlier this week:
"The biggest influence on inflation is oil. Tesla is changing the automobile market and as demand for electric cars picks up, it will impact oil prices over the long run. Why do you think the Saudis are selling Aramco? They see the writing on the wall and need to diversify their economy. Netflix is also impacting inflation. As people stop going ot the movies, they stop going out and spending on restaurants and order more as they stay home."
I told him that explains why shares of Domino's Pizza (DPZ) have been on a tear over the last five years while other restaurant stocks haven't been sinking (click on image):

Now, this comment is called the Bezos and Buffett but so far, I've only focused on Amazon.

Matt Scuffham of Reuters reports, Shares in Canada's Home Capital surge as Buffett rides to rescue:
Warren Buffett's Berkshire Hathaway Inc (BRK) is providing a C$2 billion loan to Home Capital Group Inc (HCG.TO) and taking a 38 percent stake in the mortgage lender, a move which is pressuring short sellers who targeted the stock as Canada's housing market has turned riskier.

Shares in Home Capital closed up 27 percent on Thursday.

Shares in other Canadian alternative lenders also rose on Thursday. Equitable Group Inc (EQB.TO) closed up 12.5 percent. Street Capital Group (SCB.TO) closed up 8.3 percent. Shares in mortgage insurer Genworth MI Canada Inc (MIC.TO) were up 11.5 percent.

The deal may bring to a close a two-month effort by Home Capital's board, and advisers RBC Capital Markets and BMO Capital Markets, to replace a costly credit facility with the Healthcare of Ontario Pension Plan (HOOPP) and shore up the lender's balance sheet.

The credit facility was arranged earlier to provide funding for Canada's largest non-bank lender which had suffered from the withdrawal of 95 percent of its high interest deposits in the past two months.

Alan Hibben, a former Royal Bank of Canada executive who was recruited to the Home Capital board last month, said over 70 parties had expressed interest in investing in the lender. In an interview, Hibben said Home Capital was drawn to Berkshire Hathaway because of Buffet's credibility with both investors and depositors.

"The board decided it would be nice for a sponsor to give us a view where somebody could say 'wow, if that smart person thinks the Home Capital business model and portfolios are good, I'm going to think that'," he said.

Hibben said Buffett had become involved "later in the process" with Home Capital approaching Berkshire Hathaway rather than the other way round.

Home Capital has played an important role in Canada's mortgage market, lending to new immigrants and self-employed workers who may not be able to get loans from the country's biggest banks.

But home prices in Toronto and Vancouver have fallen after the government introduced measures to cool overheating prices with household debt in Canada has reaching record levels.

Investors are wondering whether the deal will be as successful as Buffett's decidedly bigger deal to buy Goldman Sachs preferred shares during the global financial crisis in 2008.

“Home Capital’s strong assets, its ability to originate and underwrite well-performing mortgages, and its leading position in a growing market sector make this a very attractive investment,” said Berkshire's chairman Warren Buffett, in a statement on the deal released by Home Capital on Thursday.


Short sellers are continuing to take positions in Home Capital though, aiming to profit by selling borrowed shares on the hope of buying them back later at a lower price.

Combined short interest in the company's Canadian and U.S.-listed shares stands at about $183 million, up $62 million this month, according to data from financial analytics firm S3 Partners.

Marc Cohodes, a short seller who has been betting against Home Capital for two years, said on Thursday he continued to do so.

"If it wasn't Warren Buffett's name, the stock would be way, way way, down today," he said in an interview.

Home Capital was forced to raise new capital after depositors rushed to withdraw funds from its high-interest savings accounts. They pulled 95 percent of funds from Home Capital's high-interest savings accounts since March 27, when the company terminated the employment of former Chief Executive Officer Martin Reid.

The withdrawals accelerated after April 19, when Canada's biggest securities regulator, the Ontario Securities Commission, accused Home Capital of making misleading statements to investors about its mortgage underwriting business.

Home Capital reached a settlement with the commission last week and accepted responsibility for misleading investors about mortgage underwriting problems.

"The 'endorsement' from Warren Buffet may prove to rehabilitate depositor confidence, thus turning deposit flow positive," said National Bank of Canada analyst Jaeme Gloyn.

The Berkshire credit agreement comes with an interest rate of 9.0 percent, with a standby fee on funds not drawn down of 1.0 percent, compared with 2.5 percent previously.
Katia Dmitrieva and David Scanlan of Bloomberg also report, The real reason Warren Buffett is rescuing Home Capital:
Warren Buffett has become the lender of last resort for Home Capital Group Inc. The billionaire investor agreed to buy shares at a deep discount and provide a fresh credit line for the Canadian mortgage company, tapping a formula he used to prop up lenders from Goldman Sachs Group Inc. to Bank of America Corp.

Buffett’s Berkshire Hathaway Inc. will buy a 38 per cent stake for about $400 million and provide a $2 billion credit line with an interest rate of 9 per cent to backstop the embattled Toronto-based lender, Home Capital said late Wednesday in a statement. The interest on the one-year loan would net Berkshire at least $180 million if it’s fully tapped.

“While the terms of the new credit line with Berkshire Hathaway remain harsh, we believe the purpose of this loan is to motivate Home Capital’s management to bolster their own funding sources,” said Hugo Chan, chief investment officer at Kingsferry Capital in Shanghai, which owns shares in Home Capital. “This again shows Mr. Buffett’s masterful capital allocation skills,” said Chan, citing his investment motto: “be greedy when others are fearful.”

Home Capital shares surge as Warren Buffett rides to the rescue

The financial backing from the billionaire investor is poised to send the stock higher Wednesday, though it comes at a cost, in keeping with his past bailouts of financial firms. Buffett has buoyed some of the biggest U.S. corporations in times of trouble, including a combined $8 billion injection to prop up Goldman Sachs and General Electric Co. when credit markets froze during the 2008 financial crisis.

Berkshire’s purchase of $5 billion of Goldman Sachs preferred stock paid Buffett’s company an annual dividend of 10 per cent, and the billionaire also got warrants he later used to get more than $2 billion of the bank’s shares in a cashless transaction.

Deal Discount

In the Home Capital deal, Buffett’s firm agreed to pay an average price of $10 a share, a 33 per cent discount to yesterday’s closing price of $14.94. Berkshire would become the largest shareholder in Home Capital, which has a market value of $959 million.

“If you have the Warren Buffett seal of approval, people will take you more seriously than if you don’t,” said Meyer Shields, an analyst with Keefe, Bruyette and Woods. “So you sort of look beyond the settlement and say, ‘OK, what matters most now is that Warren Buffett trusts this company. And that in turn, allows Warren Buffett to get much better returns on capital than maybe some other lender would have been able to.”

The $2 billion credit line is only marginally cheaper than the emergency credit provided by the Healthcare of Ontario Pension Plan, which company directors have termed as “costly.”

Under the new credit agreement, the interest rate on outstanding balances will fall to 9.5 per cent, from 10 per cent under the existing HOOPP line. The rate will drop to 9 per cent after the initial investment is completed. The standby fee on undrawn funds will dip to 1.75 per cent from the current 2.5 per cent, then fall further to 1 per cent. The credit line is for one year. Home Capital has drawn about $1.65 billion from the HOOPP loan.

The investment “is a strong vote of confidence,” in the long-term value of the business, Brenda Eprile, Home Capital’s chairwoman, said in the statement.

New Terms

The move is the latest sign of a turnaround in the 30-year-old lender after a regulator in April accused it of misleading shareholders on mortgage fraud, which sent its shares tumbling, sparked deposit withdrawals and threatened to disrupt Canada’s real estate sector. Earlier this week, Home Capital agreed to sell a portfolio of commercial mortgages to affiliates of KingSett Capital Inc. for $1.16 billion in cash.

“Home Capital’s strong assets, its ability to originate and underwrite well-performing mortgages, and its leading position in a growing market sector make this a very attractive investment,” Buffett said in the statement.

The share purchase will be done in two parts: an initial investment of $153 million for about a 20 per cent equity stake, then an additional investment of $247 million taking the stake to about 38 per cent. The second phase requires extra approvals.

Berkshire will not be granted any rights to nominate directors and has agreed to only vote shares representing 25 per cent of the company’s stock, Home Capital said.

Home Capital shares have almost tripled since bottoming in May when its troubles began to accelerate, though remain about 73 per cent down from their peak in 2014. The company last week took full responsibility over allegations the lender misled shareholders about mortgage fraud and agreed with three former executives to pay more than $30 million to reach settlements with regulators and investors.

Buffett’s Berkshire Hathaway is wading into a tense Canadian housing market, with Toronto house prices cooling after being hit with a 15 per cent tax on foreign buyers and tighter mortgage regulations, and confidence shaken by the Home Capital drama. Meanwhile, prices are surging in Vancouver again after being sideswiped by similar policy moves.
There's no doubt the "Buffett effect" boosted shares of Home Capital Group this week but I would seriously take any profits if you risked capital and bought shares at the bottom (click on image):

I didn't buy shares of Home Capital when they tanked because I don't have Buffett's deep pockets and because I don't like the sector from a macro perspective. I can also guarantee you Buffett won't make anywhere near the killing he made when he bought Goldman Sachs's preferred shares during the crisis.

But I had a feeling something was going to happen after I wrote my comment on Canada's pensions to the rescue where I noted that pension heavyweights Claude Lamoureux, Ontario Teacher's former CEO, and Paul Haggis, the former CEO of OMERS are joining Home Capital's Board.

Home Capital approached Warren Buffett but don't kid yourselves, Claude Lamoureux, Paul Haggis and even former Board member, HOOPP CEO Jim Keohane certainly had something to do with facilitating this deal.

[Note: I send my blog comments to Warren Buffett's Executive Assistant, Debbie Bosanek, but I doubt he reads them. The Globe and Mail reports that Buffet's interest in rescuing Home Capital Group was piqued by an email from 82-year-old Don Johnson, a Canadian banker who sends his thoughts to the investment guru now and then.]

I asked Jim Keohane how this deal will impact HOOPP's investment earlier today and he replied: "Buffet will provide a line of credit at a slightly better rate and Home will pay ours off.  Our loan was always intended to be a short-term liquidity fix and we expected that we would get paid back in a relatively short time frame."

Jim is at an offsite strategic retreat discussing HOOPP's long-term strategy (I wish I was a fly on the wall there to listen in).

Anyway, I wish all of you a great weekend and all Quebecers a Happy St-Jean Baptiste Day! Please remember to support my blog by donating or subscribing via PayPal at the top right-hand side under my picture.

Below, Federal Reserve of Chicago President Charles Evans speaks to CNBC's Steve Liesman about the Fed's inflation target, the outlook for rate hikes and the state of the US economy.

And Alan Hibben, Board member at Home Capital, explains how the company secured a $1.5 billion lifeline from the Oracle of Omaha. Again, there was a process, and whle the provincial government didn't have anything to do with this deal, I'm sure Claude Lamoureux, Paul Haggis and Jim Keohane did facilitate this deal. They all have solid reputations that helped ease Buffett's concerns.

And Berkshire Hathaway's Warren Buffett discusses Jeff Bezos' extraordinary success with Amazon, calling him 'the most remakable business person of our age'. No doubt, Bezos is changing the world in ways we can't imagine, but my fear is the world isn't ready for such disruptive change and we need to address this and rising inequality in order to sustain a vibrant and healthy democracy.

Remember what Buffett once said:"The marginal utility of an extra billion to me is not as much as it can be to millions of others in desperate need."

Interestingly, Jeff Bezos hasn't signed the Giving Pledge that Buffett, Gates and other billionaires have signed but he is now looking to donate billions to philanthropy and is looking for help (see clip below).

There are many great philphilanthropic causes but I would urge Bezos and the world's billionaires to figure out ways to help the poor and disabled to earn a living and stop being marginalized by society.

Thursday, June 22, 2017

GE Botches Its Pension Math?

Nir Kaissar of Bloomberg reports, GE Botches Its Pension Math:
It’s time for General Electric Co. to do some soul-searching about its pension problem.

As Bloomberg News reported last week, GE’s pension was underfunded by a staggering $31.1 billion at the end of 2016 -- the biggest shortfall among S&P 500 companies.

So far, GE seems to be pointing fingers at everything but itself. Company spokeswoman Jennifer Erickson has attributed the pension predicament to the 2008 financial crisis and subsequent low interest rates.

In fairness, GE’s pension was in good health before the financial crisis. It was overfunded every year from 1999 to 2007, and GE’s surplus was $15.2 billion at the end of 2007. But in 2008, the pension portfolio tumbled by roughly 28 percent, and suddenly it was underfunded by $6.8 billion.

Turning Point

GE's pension fell deeper into the red after the 2008 financial crisis (click on image):

That’s when GE made some classic blunders. First, it panicked when markets declined and sold its risky assets when it should have hung on to them -- or bought more of them. GE allocated 80 percent of its pension portfolio to risky assets during the boom years leading up to the crisis from 2003 to 2006. The decline in the value of those assets in 2008 reduced GE’s risk allocation to 68 percent. But after the recovery in 2009, GE lost its nerve and sold some risk assets. By the end of 2010, GE’s allocation to risk was 66 percent, which is roughly where it remains today.

All Shook Up

GE lost its taste for risk after the 2008 financial crisis (click on image):

GE also blundered by chasing alternative investments after the crisis. From 1999 to 2008, the pension had no alternative investments. But by the end of 2009, GE had allocated 14 percent of its portfolio to alternatives.

It’s easy to see why alternatives were appealing at the time. Alternatives held up far better than the market during the crisis, in large part because of their ability to short stocks. The HFRI Fund Weighted Composite Index was down 19 percent in 2008, while the S&P 500 was down 37 percent, including dividends. Overseas stocks fared even worse.

Traumatized by the crisis and dazzled by alternatives, GE sold more of its beaten-down risk assets to make room for alternatives -- a classic case of looking in the rear-view mirror instead of the windshield. The S&P 500 has returned 18 percent annually since March 2009 through May, while the HFRI Index has returned just 6.2 percent. Overseas stocks, too, have outpaced the HFRI Index by a wide margin.

GE’s biggest blunder, however, predates the financial crisis. A critical assumption in every pension plan is the expected return from the pension’s portfolio. The higher the expected return, the less the company must contribute to its pension to meet future obligations, and vice versa.

In 1999, GE assumed that its pension portfolio would return 9.5 percent annually. At first glance, that seems like a reasonable assumption. GE’s pension portfolio is highly correlated with a 75/25 portfolio of U.S. stocks and bonds, as represented by the S&P 500 and long-term government bonds. That correlation was 0.92 between 1999 and 2016.

This 75/25 portfolio returned 9.4 percent annually from 1926 to 2016, including dividends -- the longest period for which returns are available.

But the devil is hiding in that return. It happens that the two decades before GE chose its expected return of 9.5 percent in 1999 included one of the biggest bull markets in history. From 1981 to 1998, the 75/25 portfolio returned 16 percent annually. Before that, it had returned half as much, or 8.3 percent annually, from 1926 to 1980.

Given the moment, the prudent assumption in 1999 would have been that returns would be lower over the next two decades. And that’s exactly what happened. That 75/25 portfolio returned 6.4 percent annually from 1999 to 2016, far lower than GE’s expected return of 9.5 percent. GE’s portfolio returned roughly 6 percent annually over that period.

In Step

GE's pension portfolio has been highly correlated with a simple portfolio of U.S. stocks and bonds (click on image):

GE has since tempered its expectations. It now assumes a 7.5 percent annual return. But that may still be too high. Long-term government bonds currently yield 2.2 percent to 2.7 percent, depending on maturity. The S&P 500’s earnings yield is roughly 4 percent, based on 10-year trailing average positive earnings. Earnings yields are higher for overseas stocks, but even so, it’s hard to cobble together an expected return of 7.5 percent.

Lower Expectations

I suspect GE knows all this, which points to a bigger problem than basic arithmetic. A lower expected return would require GE to increase its pension contributions. That would strain GE’s financial condition in the near term -- and by extension its stock price. That’s not what shareholders want to hear.

But GE has little choice. The longer it puts off the hard decisions, the costlier its pension problem will become. The market will eventually acknowledge that reality, and perhaps it already has. Since Bloomberg reported GE’s pension woes last Friday, its stock is down 3 percent through Tuesday, while the S&P 500 is up 0.2 percent.

The right answer is simple. The only question is whether GE has the stomach to acknowledge it.
Michael Hiltzik of the Los Angeles Times also reports, GE spent lavishly on shareholders, shortchanged pensions and still landed in a deep hole:
It’s customary to laud a departing corporate chief executive as a giant of industry and a management genius. That’s the tongue bath General Electric’s Jack Welch received when he retired in 2001. Not so much his successor Jeffrey Immelt, whose legacy already is being panned weeks ahead of his Aug. 1 scheduled departure.

Among other things, a close look is being taken at Immelt’s lavish spending on stock buybacks, especially over the last two years at the behest of the company’s biggest and richest shareholders. A new analysis by Bloomberg contrasts the nearly $46 billion GE spent to appease those shareholders in 2015 and 2016 with its chronic and growing underfunding of its pension plans.

By Bloomberg’s reckoning, the $31-billion shortfall in all GE’s pension plans — about 30% — is the biggest among companies in the Standard & Poor’s 500 by far. Rectifying the shortfall could create a long-term drag on earnings for Immelt’s successor as CEO, John Flannery.

Despite that, Flannery delivered the obligatory paean to Immelt’s leadership when his ascension was announced. (Immelt will remain chairman until Dec. 31.) “I am privileged to have spent the last 16 years at the company working for Jeff, one of the greatest business leaders of our time,” Flannery said, praising Immelt for having “created a vision for the GE of the future.”

Yet Immelt’s tenure has been nothing for investors to laud. Since he took over in September 2001, GE shares have returned a total of about 18% in price appreciation and dividends. In the same period, the S&P 500 has returned 195%.

Immelt gained nothing by paying off investors such as Nelson Peltz, whose Trian Partners held a $2.5-billion stake in GE as of October 2015. Peltz proposed that GE return to shareholders as much as 40% of its market capitalization (then about $260 billion) by the end of 2018, a process he said would raise its share price to $40 to $45 by the end of this year.

As we write, GE is short of both goals: Its current share buyback program totals $50 billion, about half what Peltz advocated, though the company has said that buybacks, dividends and spinoffs will return $90 billion to investors by the end of next year. Its share price is just shy of $29, never having risen higher than $30.86 (last December).

The company’s share repurchases coincided with a distinct underfunding of its pension plans. The buybacks came to $23.7 billion in 2015, including the equivalent of $20.4 billion from its spinoff of much of its GE Capital unit as Synchrony, and $22 billion more in 2016. Meanwhile the pension plans received only about $2 billion.

Partially as a result, the company’s financial disclosures show the shortfall growing within its main plan, covering 231,000 retirees and families and about 242,000 current and former workers and other plans, including those inherited via acquisitions, covering about 120,000 current and former workers. In 2015, the pension obligations of those plans came to about $90.3 billion and their assets to $63.1 billion, for a shortfall of about 30%. Last year, obligations had grown to about $94 billion and assets to about $63 billion, for a shortfall of about 33%.

As Bloomberg observes, GE’s options for closing the gap are limited. It could borrow to cover the expense, except it’s already a highly leverage corporation. And its expectation for long-term growth within the pension portfolio is 7.5% annually, which implies it will have to keep the portfolios heavily stocked with equities, which currently constitute about 56% of their holdings. One analyst cited by Bloomberg suggests that, given the ramp-up in premiums being charged on underfunded plans by the government’s Pension Benefit Guarantee Corp., which insures corporate pension plans, it may be worthwhile for GE to spend less on share buybacks and use the money to close the pension gap.

As a final irony, consider that Immelt has little to worry about in his own pension. As part of his retirement package, according to corporate disclosures, he’s due personal pension benefits worth nearly $82 million.
Of course, what else is new? Corporate America's CEOs have discovered the value of pensions -- their own pension -- as a source of lucrative compensation to add on top of their already egregious compensation package which they manipulate through share buybacks, all part of profits without prosperity.

Now, I'm not going to castigate Jeff Immelt, the outgoing CEO. GE is a monster conglomerate and I personally think even if God was its CEO, it wouldn't have made much of a difference. In my opinion, GE is way too big, too bulky, too lethargic and needs to rethink its entire strategy, talk to Blackstone and other PE shops to sell off more assets and refocus its strategy.

But GE's pension problem won't go way. I read Bloomberg's analysis on the $31 billion pension hole and I'm afraid to say, it's only going to get worse in the next few years as rates plunge and stay at ultra-low levels, and risk assets get clobbered.  The pension storm cometh and it will impact all pensions, public and private.

This is why it's hard for me to get excited about GE's stock (GE) going forward. Yes, the company pays out a decent dividend but a slowing US and global economy and growing pension problem don't bode well for its shareholders in the future, which is why I would be cautious buying shares at these levels (click on image):

Sure, the company can increase share buybacks but not if its pension deficit keeps growing and not if credit markets get roiled, which will make it more difficult for a highly levered GE to borrow to buy back shares or to contribute to its pension plan.

While GE needs to rethink its pension strategy, I strongly believe America needs to rethink its pension policy as public and private pensions crater, leaving millions exposed to pension poverty.

Let me be blunt. In order to "make America great again", you need to bolster corporate and public defined-benefit plans, introduce realistic investment assumptions, improve governance, and adopt some form of risk-sharing when plans run into trouble (read more about this in my comment on the pension prescription).

Is the solution to GE's pension woes more hedge funds and more private equity funds? I actually would beef up alternatives in a deflationary environment but I would choose my partners and strategies very carefully.

But let me be clear, more alternative investments won't cure America's growing pension crisis. I personally think the time has come to enhance Social Security to adopt a similar model to what we have in Canada with CPP assets being managed by the CPPIB. In order to to do this properly, they need to get the governance right.

In fact, I envision a future where all corporations get out of the pension business to focus only on their core business and retirement will be handled by the federal and state (provincial) governments using large, well-governed public pension plans. There will be resistance to such change but it's the only way forward and it makes good pension and economic sense to do this.

One thing is for sure, the status quo isn't working and is leaving too many Americans exposed to pension poverty. It's not just GE's botched pension math that worries me, it's that of the entire country where too many public and private pensions are chronically underfunded.

Below, Bloomberg reports GE's new head will focus on cash and growth. Mr. Flannery will need to focus on a few things, including the pension time bomb. I suggest he talks with the folks at the Caisse who just signed a deal with GECAS. They are in a better position to guide him on how to address the company's growing pension woes. All I can say is don't ignore this problem, it will get much worse.

Wednesday, June 21, 2017

PSP Pushes Further Into Renewables?

Benefits Canada reports, PSP to become largest shareholder of U.S. renewable energy company:
The Public Sector Pension Investment Board is moving to become the largest shareholder in U.S.-based Pattern Energy Group Inc. as part of a series of transactions aimed at supporting a major expansion of the renewable energy company.

According to the details announced yesterday, the pension fund will purchase about 10 per cent of Pattern Energy stock and will co-invest US$500 million in projects acquired by the renewable energy company.

“With these exciting initiatives, we have created an extraordinary opportunity to continue our growth,” said Mike Garland, chief executive officer of Pattern Energy.

“Pattern Energy’s investment in the development business allows us to improve our margins and secure access to a tremendous pipeline of new projects,” he added. “The strategic relationship with PSP Investments provides us with increased capital flexibility for new opportunities, while allowing us to meet our growth targets.”

Pattern Energy’s investment plans include developments focused on wind, solar, transmission and storage projects in the United States, Canada and Mexico. “This relationship grants us access to a portfolio of projects and a source of new assets in renewables, and we believe it will provide good and stable returns for our contributors and beneficiaries,” said Patrick Samson, managing director for infrastructure investments at PSP Investments.

The co-investments include the acquisition of a wind project in each of British Columbia and Quebec. The federal public sector pension fund will also acquire a 49 per cent stake in a Texas wind project from Pattern Energy. Pattern Energy has a portfolio of 20 wind power facilities, including the two projects it’s acquiring, with a total owned interest of 2,736 megawatts in the United States, Canada and Chile.

In other investment news, the Ontario Teachers’ Pension Plan is investing in recruitment company CareerBuilder. According to a news release issued yesterday, an investor group led by Apollo Global Management, along with the Ontario Teachers’ Pension Plan, will acquire a majority of the outstanding equity interests in CareerBuilder.
Karl-Erik Stromsta of Recharge News also reports, Canadian pension fund PSP to buy largest stake in Pattern Energy:
Canada’s Public Sector Pension Investment Board will acquire nearly 10% of the shares of Pattern Energy, becoming the wind-focused US yieldco’s largest shareholder, in a deal Pattern says underscores growing investor confidence in the renewables sector.

PSP Investments, among Canada’s largest pension investment managers, will acquire 8.7 million shares of Pattern Energy from its privately held sponsor company, worth $206m at their closing price of $23.69 on Friday.

PSP Investments will also co-invest $500m in projects being acquired by Pattern Energy, including stakes in the recently completed Meikle wind farm in British Columbia and the Mont Sainte-Marguerite project in Quebec due for completion later this year.

PSP is part of a growing body of Canadian investment funds and energy companies moving aggressively into renewables. San Francisco-based Pattern, whose shares are listed in both the US and Canada, is a sizeable player in the wind markets of both countries.

Pattern Energy was the 11 th largest owner of US wind capacity at the end of 2016, with 1.8GW, according to data compiled by the American Wind Energy Association. The yieldco owns 2.6GW of renewables capacity overall, and has targeted 5GW by 2020.

“This relationship grants us access to a portfolio of projects and a source of new assets in renewables, and we believe it will provide good and stable returns for our contributors and beneficiaries,” says Patrick Samson, PSP Investment’s managing director for infrastructure investments, noting that renewables are “the fastest growing market of power generation”.

Shares of Pattern Energy rose 3.4% in early trading Monday on the news, to $24.50, their highest point since mid-2015.

For much of the past two years, Pattern's shares have traded below their 2013 initial public offering price of $22, amid persistent investor concerns about renewables yieldcos in the wake of SunEdison's bankruptcy.

But the tides have been turning for yieldcos this year, with Pattern’s shares up more than 28% in 2017.

Pattern Energy invests in Pattern Development 2.0

PSP’s investment comes as part of a flurry of deals and reshuffling within the Pattern family of companies, which includes the publicly listed yieldco Pattern Energy and two privately held developers – Pattern Development 1.0 and Pattern Development 2.0, which are owned by US private-equity firm Riverstone Holdings.

Late last year a single development company – Pattern Development, known as Pattern Energy's "sponsor" – was split into two companies: Pattern Development 1.0 and Pattern Development 2.0.

Pattern Development 2.0 owns the bulk of the early- and mid-stage renewables projects in the development portfolio, while Pattern Development 1.0 has held the controlling stake in Pattern Energy and most of the late-stage projects expected to be sold – or “dropped down” – to the yieldco.

The thinking behind separating Pattern Development 2.0 into its own early-stage development company was that it would be easier to raise capital for new projects and expand the development pipeline.

Since the creation of the separate development companies, Pattern Energy has signaled the likelihood that it would invest directly in Pattern Development 2.0.

On Monday Pattern Energy confirmed it will make an “initial” $60m investment into Pattern Development 2.0 – giving it a 20% stake – with an option to invest up to $300m and acquire the entire company. In doing so, Pattern would tie together the early-stage development and project operations activities into a single publicly-listed company.

As a result of the transaction, PSP will indirectly become an owner of Pattern Development 2.0 through its stake in Pattern Energy.

Meanwhile, Pattern Development 1.0 will "gradually wind up its business", selling its remaining projects to Pattern Energy over time, the company says.

“Pattern Energy’s investment in the development business allows us to improve our margins and secure access to a tremendous pipeline of new projects,” says chief executive Mike Garland, chief executive of both Pattern Energy and the development companies.

Pattern Energy’s direct investment in Pattern Development 2.0 comes alongside a $724m package of long-term capital commitments announced for the developer from an entity managed by Riverstone, which includes money from pension, sovereign wealth, endowments, family office, and investment funds.

Pattern Development 2.0 says it has expanded its project pipeline to 10GW, encompassing wind, solar, transmission and storage projects in the US, Canada and Mexico.
PSP Investments put out a press release which you can read here. It partnered up with Riverstone Holdings, an energy and power-focused private investment firm founded in 2000 by David M. Leuschen and Pierre F. Lapeyre, Jr. with approximately $36 billion of capital raised.

This is a huge deal which will help PSP bolster and diversify its renewable energy portfolio. In order to get a sense as to why, read about Pattern Development below:
Pattern Development is a leader in developing renewable energy and transmission assets. With a long history in wind energy, our highly-experienced team has developed, financed and placed into operation more than 4,000 MW of wind power projects. We have a global footprint currently spanning the United States, Canada, Mexico, Chile and Japan and a strong commitment to promoting environmental stewardship drives our dedication in working closely with communities to create renewable energy projects.

We have earned our position as an industry leader by combining creativity, focus and a scientific approach to discover patterns that unlock important opportunities. As a result, our company history shows consistent, groundbreaking work.

Our portfolio is full of industry firsts. Our team was the first to successfully develop a utility-scale wind energy project:
  • on Native American lands in the United States
  • on the Gulf Coast of Texas
  • in the State of Nevada
  • in the Commonwealth of Puerto Rico
We are also currently pioneering transmission projects to deliver wind energy to the Southeastern United States.

Additionally, our portfolio gives us the distinction of working with the Bureau of Land Management (“BLM”) to install a large amount of the wind power projects found on their land.

The transformational partnership structure innovated by our finance team has become the dominant model used in the wind and solar energy sectors over the last decade.

All of these accomplishments have been possible because of the way that we get the job done at every stage of the development process.

By re-examining established practices, we discover new ways to approach our projects. We discern patterns through a systematic and scientific approach, but we count on our practical know-how and industry experience to convert them into projects that perform. When we find profitable patterns, we repeat them. This cycle of discovery, deduction and development is a pattern we’ll keep repeating.
Obviously, this company is an industry trendsetter and leader in utility-scale wind energy projects. PSP made a long-term strategic investment in this sector with experts in the field.

Are there risks? There are always risks with any investment and any deal but clearly renewable energy and wind farms in particular have garnered the attention of many large Canadian pensions, not just PSP.

Renewables are the future of energy. Of course, they remain expensive. In his latest Absolute Return Letter, Oil Price Target: $0 (by 2050), Niels Clemen Jensen argues this point and ends with this comment:
As fossil fuel exploration and production ties up more and more capital, productivity growth continues to decelerate, with GDP growth ultimately turning negative. However, that is only if we cannot find a new and cheaper energy form such as fusion energy.

I am often confronted with the view that we don’t need fusion energy to fix our problems. Renewables – solar in particular – can do precisely the same. Whilst correct that greenhouse gasses will be greatly reduced as we ramp up energy production through renewables, it is still far too expensive a solution to address the productivity problem.

If governments around the world were half as smart as they claim to be, research budgets into commercialising fusion would be multiplied. It is by far the best medication for a struggling global economy, as fusion will have a much more dramatic impact on productivity and hence on GDP growth than anything automation can ever deliver.

However, it is a race against time. The global economy could quite possibly sink well before fusion reaches a state where commercialisation becomes viable – a point we won’t reach for many years. Scientists say fusion on a commercial scale is still 30 years away, but the joke is that they said exactly the same 30 years ago. Hence the need for more research resources.

Finally, before I wrap this letter up, an important point. When I say that, one day, we will no longer demand any fossil fuels, it is not entirely correct. Some residual demand for oil for various purposes (e.g. classic cars) will always exist and will probably keep oil prices above $0 for many decades, but I am sure you get my point.
I have heard plenty of people argue similar points, we need to commercialize fusion, but we're far from there. In the meantime, renewables are growing and the cost of production is falling, making wind and solar energy viable renewable energy sources.

If you have any thoughts on this topic, feel free to share them with me via my email: Don't forget to read my comment going over PSP's fiscal 2017 results.

One final note on PSP. Earlier this week, I found out its CIO Daniel Garant left the organization, which surprised me. I heard rumors he might replace Roland Lescure as the next CIO of the Caisse but there has been no official confirmation. I reached out to Mr. Garant via LinkedIn but received no response which is understandable.

Below,  CEO of Pattern Energy, Mike Garland, discusses new developments in wind energy. Also, the Ocotillo Express Wind Energy Project contains over 100 Siemens SWT-2.3-108 wind turbines and is located on BLM land outside of Ocotillo, California. The equipment is maintained by Pattern Energy Group LP. This video is a composite of 1100 frames that were each shot at f/2.8 6 sec ISO 2000 15 mm.

Tuesday, June 20, 2017

OTPP Building New Careers?

Rishika Sadam of Reuters reports, Apollo Global-led investor group to buy CareerBuilder:
A group of investors led by U.S. private equity firm Apollo Global Management LLC (APO) and Ontario Teachers' Pension Plan Board will buy a majority stake in job portal CareerBuilder, the companies said on Monday.

CareerBuilder LLC is owned by Tribune Media Co (TRCO), TV station operator Tegna Inc (TGNA) and newspaper group McClatchy Co (MNI). These current owners will all retain a minority stake, Apollo said.

Apollo did not disclose financial details of the deal.

Reuters reported last month that Apollo was negotiating a deal that would value CareerBuilder at more than $500 million, including debt.
OTPP put out a press release, Apollo Global Management-affiliated Funds and Ontario Teachers’ Agree to Acquire a Controlling Interest in CareerBuilder:
Certain affiliates of investment funds managed by affiliates of Apollo Global Management, LLC (together with its consolidated subsidiaries, "Apollo") (NYSE: APO), the Ontario Teachers' Pension Plan Board ("Ontario Teachers'") and CareerBuilder, LLC ("CareerBuilder") announced today that they have entered into a definitive agreement, pursuant to which an investor group led by Apollo along with Ontario Teachers' will acquire a majority of the outstanding equity interests in CareerBuilder. CareerBuilder's current owners, TEGNA Inc. ("Tegna"), Tribune National Marketing Company, LLC ("Tribune") and McClatchy Interactive West ("McClatchy") will retain a minority interest.

"CareerBuilder is a global leader in human capital solutions, and we are excited to work with the Company in the next phase of its growth and development," said David Sambur, Senior Partner at Apollo. "Matt Ferguson and his team have done an exceptional job capitalizing on CareerBuilder's iconic brand to create an integrated solutions software-as-a-service (SaaS) platform, and we look forward to working with the team to support the Company's continued growth and innovation."

Matt Ferguson, CEO of CareerBuilder, added, "This is an exciting next chapter for CareerBuilder. We are very proud of the work we did during our partnership with Tegna, Tribune and McClatchy, and we look forward to collaborating with Apollo and Ontario Teachers' to continue the successful transformation of our business."

The transaction includes committed financing from Credit Suisse, Barclays, Deutsche Bank, Citigroup Global Markets and Goldman Sachs & Co. LLC; all are also acting as financial advisors to Apollo, along with LionTree Advisors and PJT Partners. Morgan Stanley & Co. is acting as financial advisor to CareerBuilder. Akin Gump Strauss Hauer & Feld LLP and Paul, Weiss, Rifkind, Wharton & Garrison LLP are acting as legal advisors to Apollo. Wachtell, Lipton, Rosen & Katz LLP is acting as legal advisor to the sellers.

The proposed transaction is expected to close in the third quarter of 2017, subject to regulatory approvals and customary closing conditions. Apollo's investment is being made by the Apollo-managed Special Situations I fund.

About CareerBuilder

CareerBuilder is a global, end-to-end human capital solutions company focused on helping employers find, hire and manage great talent. Combining advertising, software and services, CareerBuilder leads the industry in recruiting solutions, employment screening and human capital management. It also operates top job sites around the world. CareerBuilder and its subsidiaries operate in the United States, Europe, South America, Canada and Asia. For more information, visit

About Apollo

Apollo is a leading global alternative investment manager with offices in New York, Los Angeles, Houston, Chicago, St. Louis, Bethesda, Toronto, London, Frankfurt, Madrid, Luxembourg, Mumbai, Delhi, Singapore, Hong Kong and Shanghai. Apollo had assets under management of approximately $197 billion as of March 31, 2017 in private equity, credit and real estate funds invested across a core group of nine industries where Apollo has considerable knowledge and resources. For more information about Apollo, please visit

About Ontario Teachers'

The Ontario Teachers' Pension Plan (Ontario Teachers') is Canada's largest single-profession pension plan, with C$175.6 billion in net assets at December 31, 2016.  It holds a diverse global portfolio of assets, approximately 80% of which is managed in-house, and has earned an average annualized rate of return of 10.1% since the plan's founding in 1990. Ontario Teachers' is an independent organization headquartered in Toronto. Its Asia-Pacific region office is located in Hong Kong and its Europe, Middle East & Africa region office is in London. The defined-benefit plan, which is fully funded, invests and administers the pensions of the province of Ontario's 318,000 active and retired teachers. For more information, visit and follow us on Twitter @OtppInfo.
In other related news, Cision PR Newswire reports, CareerBuilder Teams Up with Google to Help Connect More Americans with Jobs:
CareerBuilder's evolution into an end-to-end human capital solutions company began with operating leading job boards around the world – something it has done for more than two decades. Today, CareerBuilder is excited to announce a powerful collaboration that will bring even more visibility to its clients' job listings and help job seekers find those opportunities faster.

CareerBuilder is joining forces with Google to help power a new feature in Search that aggregates millions of jobs from job boards, career sites, social networks and other sources. CareerBuilder is fully integrated with Google to feed content to them, and will include all of its jobs from its job sites and talent networks in this new feature.

"CareerBuilder has been working closely with Google on this from the very beginning when Google was first reaching out to content providers," said Matt Ferguson, CEO of CareerBuilder. "We saw a big opportunity to increase exposure for our clients' jobs and today we stand as one of Google's biggest suppliers of jobs content. Google has enormous reach and excellent search capabilities, so why not leverage these strengths for the benefit of our clients?"

Over the last 20-plus years, CareerBuilder's model has always been to serve up jobs wherever job seekers are on the Internet, and today CareerBuilder's job search engine is on more than 1,000 sites. CareerBuilder is embracing this new feature as another distribution channel for its clients that will capture even more potential candidates.

CareerBuilder has been working with Google on different initiatives and is exploring ways in which the two companies can further collaborate.

"CareerBuilder has always had an open ecosystem because it speeds innovation and produces better outcomes," Ferguson said. "Our product portfolio has expanded so significantly – now covering everything from recruiting and employment screening to managing current employees. We think there is a great opportunity to work with Google as we grow our business."

Google has been a traffic source for CareerBuilder for several years. Six months ago, CareerBuilder announced plans to use the Google Cloud Jobs API to power searches on its job site. CareerBuilder is pairing its deep knowledge in recruitment with Google's expertise in machine learning to provide faster, more relevant results for workers looking for jobs on See the announcement here.
I don't have much to add on this deal. I'm pretty sure the folks at Apollo know how to unlock the value in CareerBuilder. Moreover, if the company is working with Google to improve its products and services, that is a huge vote of confidence in my book.

Of course, if you ask me, Microsoft's acquisition of LinkedIn will change the job search industry in ways we don't even know yet, and this represents a major threat to traditional job search companies.

How traditional job search companies respond to this emerging threat remains to be seen. Will Google try to compete head on with Microsoft and potentially acquire CareerBuilder in the future? It certainly wouldn't surprise me given the two companies are working closely together.

Below, a short clip from CareerBuilder's YouTube channel on the top jobs in America today. What about the defined-benefit industry? Oh yeah, it's shrinking, much to my dismay!