There’s an interesting article in today’s Financial Times about US bank stocks. It’s about the banks’ private credit operations, but it also bears on the administration’s misguided (in my view) campaign to replace quarterly reporting with semi-annual reports.

Rightly or wrongly, I think of private credit as an expansion of the well-established practice of manufacturing companies factoring receivables.

Let’s say my company makes t-shirts. I buy cloth from a supplier who gives me 30 days to pay them. I make the shirts instantly and send them to a mass merchant who will only take them if I give it 90 days to pay me.

For one thing, this shows that I don’t have much market power. If the terms were reversed–the retailer pays me in 30 days and I only pay the contract manufacturer after 90–I’d be up to my ears in cash equal to 60 days worth of sales. But I’m in the opposite situation, with a perennial cash deficit.

How do I deal with this shortfall? Typically, I take out a short-term loan, using my receivables as collateral.

That kind of lending is basically what private credit does.

The blowup of auto parts supplier First Brands, which was in the negative working capital situation I described above, and which massively defaulted on its short-term loans, revealed to the investment world at large how gigantic the private credit market had become …and now risky it might turn out to be.

Given the opacity of the private credit market, and perhaps memories of the banking crisis of 2008 or the implosion of Long Term Capital ten years earlier, managements of the major commercial banks observed their PE ratios beginning to contract as investors began to worry about potential exposure to private credit.

The banks’ response has been to voluntarily increase disclosure, as a way of countering this PE erosion. According to the FT, this strategy is working.

I think this makes perfect sense. Less disclosure = higher risk = lower PE ratios in response.

But it’s also what I think can happen if the administration proceeds with plans to dilute disclosure requirements for all US-traded companies.

I’ve been dancing around the pension issue for public employees in various states, including my home state of New Jersey, for some time. I use California as a barometer because it’s a big state and has lots of public disclosure about its pension situation.

To my mind, state workers tend to get lowish salaries, but relatively high pension benefits. And they tend to have defined benefit (rather than defined contribution) pension plans, meaning that on retirement they get a clearly stated annual payment, usually a percentage of salary, for as long as they live.

My observation is that, ex the federal government, public pension plans tend to be underfunded. This is not the house-on-fire issue that a privately held company would be facing. That’s because the state government has the power to raise taxes to cover any shortfall. This, of course, would not be great for the reelection prospects for anyone who employed this measure.

There’s also the issue that the stock market–arguably the source of the best long-term returns–has a tendency to raise and fall with the national economy. The traditional formula has been that returns are linked to the presidential election cycle, with 2 1/2 years of up and 1 1/2 years of down (or at best sideways).

This means that there will be times when even a well-funded pension plan will look like it’s in trouble.

Hence the appeal of private equity, which promises both extra-high returns and, because the investment aren’t publicly traded, no reflection in pricing to the occasional bad moods of Mr. Market.

There is a tradeoff for this apparent stability, as there is for any financial endeavor. In this case, there are two: high fees, and pricing is done, in effect, by the purveyor of the investment services.

So a headline in this morning’s New York Times really caught my eye: Private Equity is Stuck with 33,575 Unsold Businesses.

Hard to know how widespread this issue is or how defined benefit plans will deal with it. To my mind, it argues for a higher future allocation of funds to public markets.

This is a stock guy’s perspective, and although I’ve been heavily involved in Asian stock markets in general, and Japan’s in particular, I’m not a fixed income expert.

Having written that, my understanding is this:

the simplest case

–the Japanese 10-year government bond yields 2.8%. The comparable US Treasury yields 4.6%. That’s a 160 basis point yearly difference. Why not, then, sell Treasuries, use the money to buy JGBs and enjoy the yield pickup? If we had all done this in early 2023, however, the spread would have been between 3.4% on Treasuries and less than 0.5% for JGBs.

In addition, the dollar value of the yen has fallen from about 115 to the dollar to almost 160–something like a 30% slide. Anyone who shorted JGBs three years or so ago has picked up 5%+ on the interest rate differential plus almost a third on the yen’s decline.

but why stay simple?

…that is, why not short the JGB and buy, say, stock in Nvidia? If you did that in early 2023, you’d have made 10x your money on the stock selection, while only needing to buy back yen worth 70% of your initial loan.

The US has recently enter the forex market along with the Japanese central bank to try to prop up a sagging yen. Interestingly, the Financial Times has written that the US has not sold dollars to buy yen but has used euros held by the Fed instead. Assuming, as I do, that the FT is correct (after all, it is owned by a powerful Japanese media conglomerate), I think this means that Washington fears that dollar-based entities, like hedge funds or private equity, have done enough of this that triggering an unwind could get ugly pretty quickly. Ugly here means large-scale selling of dollar-denominated instruments like Treasuries or publicly listed domestic equities and buying yen with the proceeds. This, of course, would not be in the same league as starting a war in Iran without doing a routine ammunition check, or ICE killing citizens, or shrinking the workforce through arrests and deportations. But starting a steep stock market decline would still be very visible, as well as another sign that Washington today isn’t chock full of the best and the brightest.

I’ve just updated my Keeping Score page for market results during July.

Overall, the Energy sector was up strongly, as Iran continues to outthink the Washington high command in the latter’s attempt to destroy Iran’s nuclear program and/or seize control over oil coming out of the Middle East.

On the other hand, the IT sector fell to the bottom of the pile, as its main constituents showed both sharp up and equally sharp down momentum during the month. July was also marked by the collapse of a highly leveraged investment fund, Situational Awareness. Focused on AI, SA was apparently unable to meet margin calls during last month’s ups and downs among IT sector names.

In the mid-1980s I was managing a relatively large portfolio in the Pacific Basin ex Japan, one dwarfed by the Kuwaiti Investment Office, but not really anyone else. On the other hand, prospects for me to work on bigger markets were close to zero. One day I got a call from a much smaller, relatively obscure, firm looking for someone to turn around a train wreck of a global fund. I took the job.

My predecessor had left drawers full of antacid medication …and very little in the way of files on the fund’s holdings. Lots of charts, though.

It seems that his overriding investing idea was to buy companies whose stock had recently experienced an enormous collapse, based on reading the stock price chart. The files, which contained pretty much nothing but the charts, revealed what I think was the heart of his demise.

Brokers realized very quickly what he was looking for. So they fiddled with the X- and Y-axis of the charts he wanted–stretching out the Y and contracting the X–so that just about any company showed a massive stock price drop, followed by sideways movement. This motivated him to buy all sorts of junk.

I think this is an essential truth about charts: in a world where the SE or its foreign equivalent mandates that relevant data be disclosed and where audited financials are required, chart reading is at best a secondary skill. And you should at least have a minimum of awareness about how the charts are constructed.

(An aside: things ended up well for my train-wreck fund: one of the 30 or so dud stocks accidentally went up a lot on a legal change in Spain; I got to haggle with Li Ka shing in offloading another; a third, which would normally have taken years to unload, ended up as a key block in a weird foreign bank takeover… And the fund was small enough that mid-cap stocks in Hong Kong and Tokyo could make a big positive difference.)

There are two charting indicators that I think have merit, though:

–odd-lot short sales, which are a fabulous contrary indicator, and

–support and resistance, which are basically levels where there’s been lots of buying in the past (support) as well as levels where there’s been significant selling (resistance).

This has a bearing on IT stocks in today’s market. They’ve had massive selling over the past weeks. But just as trees don’t grow to the sky, they also don’t sink below ground level.

My guess is that what we’re seeing today is IT stocks, chip and other component stocks in particular, hitting support.