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So Much For Goldilocks

Stock prices are high and fairly stable, while interest rates are low and fairly stable. A casual observer might infer from this that the global financial markets are experiencing one of those fabled Goldilocks moments where everything is just right.

But under the surface things are anything but just right. Among the high (or low)-lights:

Banks have suddenly stopped lending to each other. One of the safest ways for a big bank to put money to work is to lend it for very short periods, say overnight, to other big banks. In normal times this kind of lending happens on a vast scale without drama of any kind. But lately banks have gotten cold feet, demanding ever-higher interest rates from their brethren and threatening to screw up all kinds of activities that depend on ready cash.

The Fed, as a result, was forced to dump tens of billions of dollars into the repo market each morning for the past week, a kind of baby QE that was as baffling as it was sudden. When asked why this was happening the best the Fed could come with was that are difficulties with the market’s “plumbing.”

As any good doctor knows, half the battle is giving the complaint a name, because a patient’s imagination is frequently much worse than the reality. Our inability to explain the sudden repo market seizure has participants wondering if they’re witnessing heartburn or full-on cardiac arrest. This is not conducive to frictionless lending. As a money manager told CNN: “If the Fed can’t maintain orderly cash markets in quiet times, what might happen during chaotic ones?”

Meanwhile, at the very opposite end of the risk spectrum, the IPO market is behaving a lot like the repo market, with deals being pulled and offerings that do happen trading down hard rather than up big.

Here’s an excerpt from an overview published today by Reuters

After WeWork debacle, IPO market slams brakes on unprofitable companies

Companies making their debut on the U.S. stock market are getting a rough welcome, especially if they are losing money, casting a shadow over the calendar for initial public offerings for the rest of the year.

The surprise postponement of the WeWork IPO has underscored how confidence is eroding in the market both for companies looking to raise capital and investors.

A more discerning market for initial public offerings continued to punish Peloton Interactive on Friday, a day after it began trading, as shares of the fitness startup fell 4% to $24.74. The company is now trading 15% below its Wednesday IPO price.

In the past, public market investors have typically expected companies to become profitable within 18 months or so of an IPO. This timeline has been relaxed with money managers eager to add businesses with fast-growing revenue to their portfolios.

Recent deals, however, suggest an uncertain economic outlook is pushing investors to be more selective about the loss-making companies they are willing to back.

Peloton reported rapid top-line growth of 110% during the fiscal year that ended June 30. But the company also showed negative operating leverage, with operating expenses surging 147% over the prior year.

Loss-making teeth-alignment company SmileDirectClub SDC.O earlier this month became the first U.S. IPO in three years to price above its target range and close down on its first trading day, according to research firm Renaissance Capital.

The average IPO return in 2019 is now about 9%, down from more than 30% at the end of June and more than 18% about two weeks ago.

The common theme here is that things requiring a leap of faith — like Citigroup avoiding a derivatives implosion in the next 24 hours or WeWork growing fast enough in 2020 to turn negative cash flow positive — are no longer comfortable bets for big players in the financial markets.

As Reuters notes, “a discerning market” might not be nearly as hospitable for current asset valuations and financial practices as was the past few years’ trusting one.


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