Weekly Research Briefing: Playing Checkers

@GunjanJS: "There were $9.8 billion of outflows from investment-grade bond funds over the past week, the 4th largest outflow on record." (JPMorgan)

"40% of our deficits are financed by foreigners. That’s what we’re worried about—manufacturing overseas. How about our own ownership of our own credit markets being so large overseas? That is a risk, and it’s a big one. So, I’m not surprised to see a deterioration of the dollar, which means dollars are coming back." – BlackRock CEO Larry Fink

@lisaabramowicz1: Trump pivoted, but we’re not going back to where we were before. We have learned a few things: 1) Trump will respond to a certain level of pain in markets. 2) The Treasury market is perhaps the most important player in markets right now. 3) There can be exemptions.

For those confused why there was so much focus on Treasuries, let’s take a moment to break it down. The US bond market is the backbone of the country’s economy. And as Trump’s trade war kicked in at the stroke of midnight on Wednesday, it began to seize up.

When there’s turmoil in financial markets, investors usually seek the safety of Treasuries. But this time they were selling off — and sharply.

Hedge funds played a role here. A common “relative-value” strategy that some funds employ is something called the basis trade. This involves selling Treasury futures and buying Treasury bonds, skimming off a small, typically risk-free premium of a few basis points in the process.

Since these trades are thought of as very safe, they usually have a huge amount of leverage. So when Treasuries unexpectedly sold off in a major way these last few days, it triggered a cyclical loop of liquidations, margin calls and more liquidations across the hedge fund industry.

While Trump wanted to rattle the US’s trading partners, he likely didn’t plan on a full-blown meltdown. Ultimately, a call had to be made.

@lisaabramowicz1: "If recent disruption in the US Treasury market continues we see no other option for the Fed but to step in with emergency purchases of US Treasuries...This would be very similar to the Bank of England intervention following the gilt crisis of 2022:" DB's Saravelos

"I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody." (James Carville)

Erecting a protectionist trade wall around the U.S. is a brilliant idea … if your goal is to elegantly reduce American prosperity. (Scott Galloway)

@wallstengine: Oaktree’s Howard Marks: “I consider the tariff developments thus far to be what soccer fans call an own goal...They’re highly analogous to Brexit, and we know how that turned out. Brexit cost the British mightily in terms of GDP, morale, and alliances, and it harmed their reputation for governance and stability. All of this damage was self-inflicted.”

The outlook remains fluid, particularly with respect to the China tariffs. Will the exemptions (or rate reductions) for telecoms and semiconductor equipment remain in place? Will Chinese firms be able to reroute their exports to the US via other Asian countries such as Vietnam? And is there any hope for an agreement that brings broad tariff rates back to levels which allow for at least a moderate amount of mutually beneficial trade outside of favored products and sectors? In part because of these uncertainties and in part because it is unclear how the US economy will cope with the dramatic increase in uncertainty, we still peg the probability of a full-blown recession over the next 12 months at 45% and view the bar for returning to a recession baseline as low.

"Both tariff assumptions and recent signs of macro slowing trigger the downward revision from a previous $270 projection. Some valuation compression is also warranted as a function of policy uncertainty. Bull/bear cases band the base case setup but with more upside from here to our bull case [6400] relative to downside to the bear [4700]. This leaves us constructive on the risk-reward for the balance of the year, and particularly on further pullbacks."

“The 90-day pause on reciprocal tariffs and further concessions over the weekend lessen the near-term probability of a recession, but uncertainty remains high,” said Wilson, who sees the S&P 500 trading in a range from 5,000-5,500... Morgan Stanley’s Wilson warned that the S&P 500 could slump back below 5,000 and retest last week’s lows if 10-year Treasuries yields surge above 5% from the current 4.46%. A larger trade deal with China that significantly reduces tariffs still in place would cause significant upside, he said.

@wallstengine: According to BofA’s Michael Hartnett, investors should keep selling into any S&P 500 strength until the Fed steps in and the U.S.-China trade war de-escalates. He’s calling the recent tariff chaos a shift from “U.S. exceptionalism” to “U.S. repudiation.”

Hartnett sees value in shorting equities until the S&P 500 hits around 4,800, and favors long positions in 2-year Treasuries. He warned that rising bond yields, falling stocks, and a weaker dollar are driving global liquidation—and said real policy action is likely the only way to stop it. (Source: Bloomberg)

"There's no way to cushion 145% tariffs. There's no math that you can make that work... There is no silver bullet... that's just math." – Fastenal CEO Daniel Florness

"If you start to put a 20% incremental cost on top of an aircraft, it gets very difficult to make that math work... We'll do our very best to see what we have to do to minimize tariffs." – Delta Air Lines CEO Edward Bastian

"Are you going to make that investment in Mexico for scale manufacturing? You may or may not. My guess is you probably won't, unless you have comfort... that 25% will be there for the next 15 years, 20 years... You're not going to do it if you think it could disappear in 2." – Fastenal CEO Daniel Florness

Amazon.com seller Ramon Gonzalez knew tariffs were coming. He had no idea that in a matter of a week, they would escalate enough to potentially put him out of business.

His small online shop that sells family-friendly card games has relied on regular shipments from China, where he could source low-cost goods and sell them for a small premium on Amazon. But within about a week, an already painful 54% tariff on China unveiled on President Trump’s “Liberation Day” escalated to 145%. Trump exempted smartphones and consumer electronics from “reciprocal tariffs” on Friday.

Gonzalez, 46, said the increase is far beyond what the business can absorb and one that would likely deter customers if he passed it on in the form of a price increase. He is one of millions of sellers on Amazon adjusting to a dizzying week and a half of a trade war that has shocked Wall Street and, for now, remains fixed on products arriving from China, a major source of goods sold on the e-commerce site.

Businesses large and small are confronting a similar quandary: They don’t want to damp demand by jacking up prices but can’t afford to absorb the added cost of doing business. The decisions that Gonzalez and others make will ultimately dictate the variety and price of products available to consumers.

Small and midsize companies account for $868 billion, or roughly one-third, of annual U.S. imports, according to the Census Bureau. And while they are dwarfed by global giants like Apple and Nike, these businesses also rely on overseas factories and Chinese goods that still carry steep tariffs.

Joe Fox has decided not to open his seasonal fireworks store in Leslie, Mich., this year. “The whole decision was tariff based,” said Fox, who sold fireworks imported from China. “We didn’t want to get into something that would pass along a ton of costs to consumers,” he said. “We are closing for the foreseeable future until this is sorted out.”

Trump’s tariff plan has unnerved the stock and bond markets and prompted some big companies to rethink production and prices. But the sudden shifts and repeated stops and starts in Trump’s trade policy are roiling small businesses, which typically don’t have the same leverage to negotiate with suppliers or large cash cushions.

“I don’t think they understand that a lot of little businesses are going to go away,” said Richard Leffler, president of Nils Skiwear, an apparel company in Garden Grove, Calif. His business isn’t likely to have the cash needed to cover tariffs on orders placed in early February that are slated to arrive in mid-August for ski season.

“It’s not looking very good,” Leffler said. He is weighing whether to pull the plug on production and cut his losses, or continue operating in the hope that tariffs will be reduced before his apparel from China reaches the U.S. in late summer.

@LizAnnSonders: Per @UMich, only 35% of consumers expect to see real income gains in next year … only other month with a lower percentage was September 2011

‪A sharp widening in bid-ask spreads for the median S&P 500 stock is one indication of today's poor liquidity environment. On April 7th, the bid-ask spread for the median S&P 500 stock jumped to 22 bp, the highest level since March 2020 (23 bp). The bid-ask spread over the past month ranks in the 97th percentile over the past 10 years.

‪“We’ve navigated tariffs before,” Chipman said. “However, the breadth and magnitude of the recently announced tariffs are significant given that approximately 60% of our total cost of goods are imported from China, either directly or through our domestic vendors.”

Five Below Inc. shares dropped on Friday after the retailer asked vendors to turn away products waiting for shipment in China before they set off for the US, according to a memo reviewed by Bloomberg.

Shares declined as much as 10% after shipping giant A.P. Moller-Maersk A/S sent a letter to suppliers on behalf of the discount retail chain saying that the company has elected to suspend its cargo shipments, following the US and China tariff impact. It was unclear from the memo if it went out to all Five Below vendors, or a subset.

The Maersk letter says that no containers are to be delivered to the yard starting April 10, and all containers that are loaded must be unpacked and returned to the carrier.

"In the last six weeks, we’ve seen a corresponding reduction in broad consumer confidence and corporate confidence." – Delta Air Lines CEO Ed Bastian

"Most CEOs I talk to say we are probably in a recession right now. A couple of airline CEOs told me, and one CEO specifically said, 'The airline industry is like a proverbial burden, a canary in a coal mine.' I was told that the canary is sick already... I do believe we’re probably starting, if not already in, a recession." – BlackRock CEO Larry Fink

The number of European travellers visiting the US has fallen sharply as political and economic tension and fears of a hostile border under President Donald Trump threaten the world’s most lucrative air routes.

Visitors from western Europe who stayed at least one night in the US fell by 17 per cent in March from a year ago, according to the International Trade Administration.

Travel from some countries — including Ireland, Norway and Germany — fell by more than 20 per cent, an FT analysis of ITA data showed.

The trend poses a threat to the US tourism industry, which accounts for 2.5 per cent of the country’s GDP. Some airlines and hotel groups have warned of waning demand for transatlantic travel and a “bad buzz” about visiting the US.

The total number of overseas visitors travelling to the US dropped by 12 per cent year-on-year in March, the steepest decline since March 2021 when the travel sector was reeling from pandemic restrictions, according to the ITA data.

The EU is prepared to deploy its most powerful trade measures and may impose levies on US digital companies if negotiations with Donald Trump fail to end his tariff war against Europe.

European Commission president Ursula von der Leyen told the Financial Times that the EU would seek a “completely balanced” agreement with Washington during Trump’s 90-day pause in applying additional tariffs.

But the Commission president warned she was ready to dramatically expand the transatlantic trade war to services if those talks failed, potentially including a tax on digital advertising revenues that would hit tech groups such as Amazon, Google and Facebook.

“We are developing retaliatory measures,” von der Leyen said, explaining these could include the first use of the bloc’s anti-coercion instrument with the power to hit services exports. “There’s a wide range of countermeasures... in case the negotiations are not satisfactory.”

She said this could include tariffs on the services trade between the US and the EU, stressing the exact measures would depend on the outcome of talks with Washington. “An example is you could put a levy on the advertising revenues of digital services.

The measure would be a tariff applied across the single market. This differs from digital sales taxes, which are imposed individually by member states.

Even after the president’s partial U-turn – freezing tariffs at 10% on all US imports except those from China for 90 days – markets swung from relief rally to fresh rout, as investors questioned the once unthinkable: could the US dollar be losing its unassailable safe haven status?

“The damage has been done,” said George Saravelos, the head of foreign exchange research at Deutsche Bank. “The market is reassessing the structural attractiveness of the dollar as the world’s global reserve currency and is undergoing a process of rapid de-dollarisation.”

Unlike in a typical market sell-off, the Trump crash has included US equities, government bonds, known as treasuries, and the dollar losing value in sync. That is unusual because investors normally plough into dollars and Treasury bonds in periods of uncertainty and financial distress.

For the past 80 years, the dollar has held a status as the world’s primary reserve currency; used as a store of value around the globe, as the grease in the wheels of the financial system and as the medium of exchange in trade.

The belief is that a currency backed by the government sitting atop the world’s pre-eminent economy, with the deepest capital markets, most powerful military and a political system that respects the rule of law is about as good as things get.

However, Trump is changing all that, having slapped punitive tariffs on the US’s traditional allies and enemies alike.

Taking stock of the latest data, there are indicators of growing optimism on European asset returns and waning optimism on the US. Recent inflows into European equities have been historically large. And, though foreign flows into Euro area assets have been more subdued, they have followed a similar trend. Data on global equity fund holdings released by the Swedish Investment Fund Association, for example, show a record rotation on the part of Swedish investors out of North American assets and into Swedish and European assets more broadly over the past two months.

Intel will sell a majority stake of its programmable-chip unit to private-equity firm Silver Lake.

The semiconductor company said it will own 49% of the Altera business, which it added will allow it to participate in Altera’s future success while focusing on its core business.

Intel is on the clock to turn things around, and recently appointed Chief Executive Lip-Bu Tan is prioritizing the core business. Tan in March said some of Intel’s non-core businesses would be spun off.

“Today’s announcement reflects our commitment to sharpening our focus, lowering our expense structure and strengthening our balance sheet,” said Tan...

Intel said Monday’s deal values Altera at $8.75 billion. The company acquired Altera around 10 years ago in an all-cash deal valued at $16.7 billion.

Over the past 25 years, buyout transactions were completed at an average EBITDA multiple of 9.6x, according to PitchBook Data, Inc. This compares to the public market index valuation of 12.1x EBITDA on average (see Chart 4.0). In other words, private equity has bought on average at a 2.5x discount to broader public market index valuations.

One may ask if the spread in valuation has eroded over time. Put simply, it has not. Across cohorts from (i) 2000-2009, (ii) 2010-2019, and (iii) 2020-2024, there has been a sustained spread between private equity buyout entry multiples and broader index valuations. In fact, the last five years had a larger public to private spread than the decade prior.

We looked at 13 equity-focused evergreen funds. While their performance history is short, evergreen funds did slightly better than closed-end PE funds and outperformed the public markets over the last five years. Will this continue? We don’t know, but if we are going to argue that evergreen funds don’t have good performance, we’d sure hate to see this data.

This table is the most compelling reason to consider evergreen strategies for all investors, not just high-net-worth investors. Sure, the underlying assets in evergreen funds are the same as (or very similar to) the assets in closed-end funds, but evergreen structures offer two massive advantages:

1. The ability to put all your money to work on day one gives you that magic of compounding returns that investors like Warren Buffett say is the secret to long-term investment success.
2. The evergreen fund manager immediately reinvests proceeds into new investments (in contrast to closed-end funds, which send proceeds back to LPs, putting the onus on LPs to sort out how to stay invested). This keeps the eighth wonder of the world working in investors’ favor.

Our corporate finance 101 textbooks tell us that, if your evergreen portfolio delivers a 12% return over 10 years—nothing heroic—then, you’d expect to have 2.5x your initial investment after eight years. Only about 6% of closed-end funds generate a 2.5x TVPI and they typically have IRRs above 20%. (Yes, your private equity portfolio construction 101 textbook tells you that your “nothing heroic” evergreen portfolio is delivering basically top-quartile fund returns.)