Weekly Reads
Weekly Reads - September 25, 2023

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Despite 10-Year U.S. Treasury yields rising to 16-year highs market-wide valuations continue to hold at levels far above what we have seen in times when yields were at these levels. 

Benchmark 10-Year U.S. Treasury yields rose to 16-year highs after the Fed commented that there could be an additional rate hike this year and fewer cuts next year. The Fed now expects a half a percentage point cut in 2024 versus June when they forecasted a cut of a full percentage point. Chairman Jerome Powell believes that the current economy and strong job growth give the Fed more leeway in keeping additional pressure on financial conditions through 2025 with less cost to the economy than in previous times of high inflation. The market seemingly agrees with this sentiment with the S&P 500 trading at nearly 23x earnings (as of August 31, 2023) far higher than the mid to high teens seen during similar periods. Regardless of the current sentiment, there are cracks that are starting to form with corporate default rates hitting multi-year highs, consumer staple/discretionary companies citing slowdowns in demand, and the job market slowing down. The market continues to shrug off these concerns fueling the stock runs of trendy stock picks even as the risk rises that the market could see a reset if economic conditions continue to turn negative.

With defaults in August reaching 2009 levels, it is clear that companies around the globe are struggling to stomach higher interest rates as consumer demand and economic condition continue to turn negative.

August is the time of the year in which corporate defaults are often at their lowest, yet this August is a different story with 16 defaults, nearly double the 10-year August average of 8.6. The future is not looking brighter with S&P Global forecasting a rise in the trailing 12-month speculative-grade corporate default rate to 4.5% in the U.S. by June 2024 (from 3.5% in 2023). The sector seeing the most defaults is media & entertainment accounting for 1/3 of U.S. defaults and 25% of total defaults in August followed by consumer products. Both sectors have struggled with consumers cutting discretionary purchases as savings built through COVID trickle down and a slowdown in the job market after a blistering 2022. Debt-laden companies are at a higher risk today as the Fed made it clear they plan on a lower rate cut in 2024 and economic conditions getting worse. Outside the U.S. things are not much better with Latin America accounting for 13 out of the 14 defaults in emerging markets year-to-date and S&P Global expecting default rates to rise in Europe to 3.75% by June 2024. As more indicators reflect the true global economic conditions it will be interesting to see how quickly markets readjust and whether trendy equities will be impacted.

Ford pausing work on their $3.5 billion EV battery plant signals that the EV targets given out by automakers are unlikely to be achieved in the foreseeable future.

Ford is pausing construction on its $3.5 billion EV battery plant with plans to limit spending for the time being. Ford’s reasoning for pausing construction is their lack of confidence they can competitively run the plant as EV prices plummet as competition intensifies. Ford’s EV battery plant was supposed to help the company build out its lithium iron phosphate (LFP)capacity via a partnership with Chinese battery maker CATL. This new plant was expected to produce 35 GWh of new battery capacity annually which can power 400,000 EVs. This battery plant would have accounted for 20% of Ford’s forecasted global 2 million output in 2026 making it a crucial piece for the company to meet its guidance. Additionally, the plant would help Ford reduce the cost of manufacturing EVs with the new batteries being manufactured as a cheaper alternative to traditional batteries. While the pause in construction can be blamed on the current autoworker strike, it is also likely that Ford is struggling to justify the returns on this new investment as EV prices have plummeted. EVs remain a loss-generating business for Ford and in a turbulent time, it could be difficult to continue to invest capital in a segment that is likely to pressure the bottom line rather than grow it. Ford’s relationship with Chinese battery maker CATL has also been under fire adding more complications to the project. With investments in EVs harder to justify as the economy weakens and incumbent Tesla pushing prices down, it will be no surprise if we see traditional automakers push back their EV targets as they balance profitability with catching up with Tesla.