POP QUIZ

What was the most valuable U.S. company in 1917? How about in 1967? (Scroll to the bottom to find out!)

IN THE NEWS

🤓 The Economic Data Wall Street Cares About is Changing

Speaking of things that have changed over the decades, as discussed in the intro, something else is very different these days in financial markets — the economic data that previously consumed investors’ attention has changed.

As Bloomberg’s Joe Weisenthal puts it, “For basically the entirety of the 2010s, the Non-Farm Payrolls report was THE top-shelf economic indicator each month…Since 2021, inflation data has been where all the action is. Inflation data is what’s moved the Fed, and what’s really moved markets.”

• For two, nearly three years, monthly inflation reports have topped investors’ minds, supplanting measures of how many jobs there are in the economy — which matter because increases/decreases can reflect whether the economy is trending toward growth or recession.

Times change: But inflation fixation is fading fast. The consensus on Wall Street is that the battle has largely been won; thus, the interest rate hiking cycle of the past 18 months is over.

• As evidence, look no further than Wall Street banks’ predictions: Morgan Stanley expects the Fed will cut rates as soon as June, while Goldman Sachs anticipates rates to fall starting in Q4 2024 with monthly cuts of 0.25% through mid-2026.

Why it matters:

So, the game on Wall Street has shifted from guessing how much the Fed will raise rates at its next meeting to forecasting when it’ll cut.

What comes next: Short of a big surprise in inflation, Weisenthal suggests we should expect the dial to turn back towards an even greater focus on the job market in the coming months.

A sharp falloff, for example, would pressure the Fed to start reducing rates sooner and in greater increments.

• Inflation, specifically measures of the consumer-price index, were the most important data releases for many investors who speculated on how the Fed would respond with rate hikes.
• As inflation normalizes, the Fed’s actions will instead be increasingly shaped by the job market.

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🏦 Top Four U.S. Banks Grab Growing Share of Profits

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Big U.S. banks keep making bank.

According to The Financial Times, nearly half of all banking profits last quarter came from just four companies: JPMorgan, Citigroup, Wells Fargo, and Bank of America. The other roughly 4,400 banks in the U.S. had to fight for the leftovers.

• That’s what high inflation and a sharp increase in interest rates will do. We suppose the run on regional banks also played a role here. Maybe just a tad.
• Kidding aside, while the banking industry’s profits fell about 5% last quarter because of rising interest costs and a decline in bond markets, banking’s Big Four crushed it.

Over the past decade, the big four have eaten up about 39% of banking profits. Recently, that number is up to almost half. The big keep getting bigger, not unlike what we’ve witnessed in Big Tech the last few years.

Each of the four has assets under management (AUM) over $1 trillion.

Recall this spring’s chaos, when Silicon Valley Bank imploded, Signature Bank failed, First Republic Bank followed suit, and depositors got scared.

Why it matters:

Rather than harm the whole industry, the regional banking mess helped the Big Four as Americans realized they might be safer with their money sitting among the (perceived) safety of the Big Four.

• Now, regional banks still have some power. You can earn a solid return by sitting on your cash in tools like high-yield savings accounts, and smaller banks have paid an average of about 3% yearly, vs. just 2% for the Big Four. (40% of accounts at the Big Four still pay no interest at all.)
• “The biggest banks have not had that much deposit pressure,” an equity research analyst said. “You see the net interest margins of the smaller banks have been hit much harder than the big banks.”

Remember: U.S. banks hold more than half of the $5.6 trillion in outstanding commercial loans, per Goldman Sachs. And small and regional banks hold more than half of that.

• If the office market craters in the next year or two — more on that below — we could be in for a high rate of defaults.

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🏢 The Big Sign That Commercial Real Estate Is In Trouble

Oh boy. Commercial real estate’s latest ominous sign: Lenders issuing a record number of foreclosure notices related to risky property loans. Many of the loans are like second mortgages and known in the industry as “mezzanine loans.”

Turmoil in the property market has been a defining storyline in 2023, but now we have some of the clearest evidence that things aren’t rosy.

Mezzanine loans have high interest rates and offer a faster, easier route to foreclosure than mortgages. The Wall Street Journal discovered 62 mezzanine loans and other, similar high-risk loans through October this year — more than double last year and probably the highest total of all time.

In short: Higher interest rates and soaring office vacancies are crushing the sector.

• The rise in mezzanine-loan foreclosures is important because it signals commercial real-estate turbulence, more so than mortgage for foreclosure rates.
•  Plus, commercial mortgage foreclosures have yet to show up in the data. It might take months or years between default and mortgage foreclosure.
• But with mezzanine loans, the foreclosing process is much swifter.

Some perspective: Mezzanine loans became popular after 2008-09. Many roads lead back to that timeframe, don’t they?

• That’s because regulators stepped up, coming down hard on big banks. Thus, they became more conservative lenders that prefer mezzanine debt because they generated high yields.

Why it matters:

Mezzanine lending combines debt and equity financing, allowing lenders to convert to equity if the loan isn’t paid on time or in full. It was a big business for firms like Blackstone, which lent hundreds of millions of bucks.

• Big mezzanine lenders used the debt to bid up prices, especially when rates were low in 2021. They also didn’t have to spend much of their own money, contributing to the inflated commercial real estate market before 2022.

Case study: The 32-story Margaritaville Resort in Manhattan’s Times Square opened in 2021 and is among the buildings caught in the mezzanine meltdown.

• Once valued at $2.4 billion, its developer took out a $57 million mezzanine loan against the building, plus a $167 million mortgage.

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TRIVIA ANSWER

The most valuable U.S. companies in 1917 were U.S. Steel and AT&T. By 1967, they were IBM, AT&T, and Eastman Kodak.