BEACONS OF THE WEEK
The two main purposes of a Lighthouse are to serve as a navigational aid and to warn ships (Investors) of dangerous areas. It is like a traffic sign on the sea.
Lighthouse Ke Ge Cape, Binh Thuan, Vietnam
Ke Ga Cape is a small island located 500 meters off the mainland and 20 kilometers away from the center of Phan Thiet City. This island is formed from granite stones with unique shapes, creating a small island of enchanting beauty. The island features this historic lighthouse which has served as an aid to navigation for over 120 years.
Île Vierge lighthouse, Plouguerneau, France
This lighthouse sits on the north-west coast of Spain. It is the worlds tallest traditional lighthouse standing at 271 feet tall. The lighthouse was built in 1902.
*Feel free to send us your photos of Lighthouses to be featured in our weekly market observations. *
Climate change
A lot is said about climate change. Many do not believe in it and believe we should not change as a society, and many believe we should do everything in our power to stop pollution through government regulation and decrease our use of fossil fuels. We think that in reality, the world should fall somewhere in between those two arguments. However, we live in a world of polarization, and a compromise is likely not attainable.
For those who say the West has a responsibility to decrease emissions and create a cleaner world, we bring your attention to this chart:
Western nations like Canada, the U.S., and countries in the European Union have rapidly decreased their CO2 emissions in recent decades. However, areas like China, India, and Africa have quickly increased their emissions. These countries and regions are still actively building coal plants while the West decommissions their coal plants due to their environmental concerns. Coal energy is the dirtiest fossil fuel energy source and is coincidentally the cheapest form of energy. Emerging and developing countries in Asia and Africa are actively looking to grow their economies and increase their output at any cost, cheap energy is preferred to clean energy as is easier to access.
The whole reason we brought this up this week is because, on a per capita basis, the U.S. is emitting the same CO2 emissions as they were during World War 2.
We understand that this is not total emissions, but the stat surprised us to say the least. Think about all the economic development the world has undergone over the last 80 years and think about the increase in demand for energy, and electricity. All that increase has somehow not led to an increase in emissions. It is quite staggering.
However, despite this progress in select countries like Canada and the U.S., the world will not stop climate change and the increase in global temperatures. The West only accounts for a portion of the world’s emissions, even if they decrease their CO2 emissions, countries like India and China will continue to increase theirs as they focus on growing their economies and improving their population’s quality of life. The entire point of this exercise is to highlight the pitfalls and gaps of the West’s focus on climate change. Even if the West completely goes renewable and stops fossil fuel usage (not possible), the world will more than likely continue to face climate change due to increased energy consumption and emissions across other regions of the world.
Always remember there is a direct correlation between energy consumption and economic prosperity across the globe.
So, before you say oil is dead, go all in on renewables, and follow the data, in reality, the world could not survive without natural gas or oil. On the other hand, ignoring renewables is not smart as one day they will more than likely power most of the electricity grids. We follow both sides of this argument and continue to analyze data and equities in both spaces to remain the most informed as possible.
However, we still believe that nuclear is the best way forward and is a great marriage of the two arguments above. It is cleaner than fossil fuels, and more reliable and scalable than traditional renewables. We remain interested in uranium and nuclear and invite you to do some of your own research on the industry.
Back from the dead (for now)
Super Micro Computer Inc. has been in the news for all the wrong reasons in recent months. SMCI’s old auditor, which was a Big 4 firm dropped them, an activist short seller (Hindenberg Research) put out a scathing report that accuses SMCI of faulty accounting, improperly recording revenue, and poor governance and the firm is also under Federal investigation according to numerous outlets. These events led to retail investors fleeing the stock they once loved. Shares have cratered from $119/share in mid-March to just $19/share as of last Friday.
Fast forward to this past Monday and the company announced some good news, news that investors were pleased to hear. SMCI hired BDO to be its new auditor. The hiring of the firm was critical as SMCI has delayed its annual report filings since August. When their former auditor publicly dropped them (we talked about this in a past edition of this publication), the Nasdaq gave SMCI a 60-day deadline to file the late report and find an auditor to sign off. That deadline was Monday. By announcing a new auditor, SMCI has some time to file its late annual report and subsequent quarterly report which have both not been released.
The California-based company saw its shares surge on this announcement, jumping 16% Monday and another 22% in early trading Tuesday. However, despite these bounces, SMCI shares are down 55% over the last month.
BDO will be SMCI’s 3rd auditor in less than 2 years.
As a reminder, SMCI has benefited from the AI wave. The company has a major relationship with Nvidia and competes with companies like Dell and Hewlett-Packard Enterprises (our favorite AI stock).
This is not SMCI’s first time dealing with legal issues. We have mentioned SMCI’s run-ins with authorities in the past. We are not going to assume everything is back to normal as of yet. We will let the cards fall when it comes to SMCI and its biggest competitors in the following months. Right now, for our investors, the risks associated with SMCI outweigh the rewards.
Flipping on China
In September, investors could not get enough China. Investors piled into Chinese ADRs and Chinese ETFs on economic and regulatory announcements from the Chinese government. The government announced increased stimulus focused on its ailing equity markets, and language that would suggest less regulation and government overreach. Numerous large investors including hedge funds and large Wall Street banks piled in. David Tepper famously went on CNBC and said he would do everything in China “stock, futures, ETFs, whatever you can buy”, Tepper’s fund was already long in China. According to 13F filings, his fund increased that exposure during the 3rd quarter.
Tepper’s largest holding according to his Q3 filings is Alibaba at 16% of his portfolio. According to filings, his Chinese exposure increased from 26% to 38% during Q3. Retail traders and institutions followed Tepper into China on economic upside hopes and attractive valuations.
Despite all these tailwinds, Chinese stocks are down over the last 6 weeks. The iShares MSCI China ETF is off more than 20% since October 7th. Why has this happened? Stimulus does not seem like it will be as large as once believed, and Trump won the election. This has completely bucked the trend of inflows into China as investors begin to flee China.
The iShares China Large-Cap ETF saw $984 billion in outflows last week, a record number. The KraneShares CSI China Internet ETF saw $710 million in outflows over the same period. Chinese ETFs overall saw record outflows last week according to Bloomberg.
These outflows come as investors worry over rising concerns over national growth outlooks and the risk of new tariffs under the Trump administration. David Solomon, Goldman Sach’s CEO said at a conference that most investors remain on the sidelines in China for numerous reasons including weak consumer confidence and difficulties getting money out of the country. We think investors will remain on the sidelines until consumption improves in China, the tariff outlook becomes clear, and more progress is made in the opening of Chinese capital markets.
We are continuing to watch China but remain on the sidelines. Although we see value, we still think investing in China is quite risky today. Our exposure to China continues to be limited to the exposure that the iShares Emerging Markets ETF is exposed to. The EEM ETF has 27% of its assets and another 18% in Taiwan. As this is a small position in client portfolios, our overall China exposure remains below a percentage point.
Insiders hit the exit door
As markets continued their roar in 2024, insiders continued to sell their stock. Last quarter, a record number of U.S. executives sold shares in their companies. According to the Financial Times, the ratio of insider sales to insider buys hit a 20-year quarterly record during the third quarter.
Insiders are selling everywhere, from bank executives at Goldman Sachs to tech executives at Palantir. Insiders are taking the recent market run-up as a time to diversify their holdings.
Many believe insiders are usually a few quarters ahead when selling stock. Perhaps some of these sales come as company forecasts are not as bright as they have been over the last 12-18 months. Regardless of how you feel about insider transactions, we again remind you to own quality and recommend that you follow insider transactions, so you do not get caught off guard.
Foreigners dumping Treasuries
Two of the world’s largest foreign holders of U.S. Treasuries sold more U.S. debt last quarter as the U.S. headed into its election season. During the third quarter, Japanese investors sold a record $62 billion in U.S. debt securities while China offloaded $51.3 billion, the second largest sum on record.
U.S. Treasury returns peaked in early September for this year. Over the last 2 months, yields have been on the rise due to inflation fears, a lack of demand from investors for U.S. Treasuries, and investors rotating capital into higher-yielding assets. We had mentioned before the election that both Harris and Trump would cause a jump in the consumer price index.
Market strategists believe Japanese investors were selling U.S. debt in Q3 due to election uncertainty, and expectations for higher yields moving forward. They believe the selling in China has been due to geopolitical concerns. The Chief Analyst at AT Global Markets stated to Bloomberg last week that he believes many will continue selling U.S. Treasuries including investors in both Japan and China. He said part of this selling is being led by traditional factors like inflation worries, and economic policies from the Trump administration as well as short-term fears like who he will be named U.S. Treasury Secretary.
Trump has already nominated numerous individuals to lead various government departments when his term starts. These individuals need to be confirmed by the Senate so we will see what happens. However, as an asset manager, the one post we are watching the closest is the U.S. Treasury Secretary. There have been rumors swirling for a few days on who Trump will tap for the position. We will highlight some of the contenders.
Before we look at who is being considered, let’s look at who held the position during Trump’s first Presidency. Believe it or not, Trump only had one Treasury Secretary during his last term. Trump nominated Steven Mnuchin, a long-time Goldman Sachs executive and hedge fund manager. Stability was rare during the first Trump Presidency, however, Mnuchin is reportedly not being considered for the role (or does not want it).
According to Polymarket, the odds-on favorite to be Trump’s Treasury Secretary is Kevin Warsh (as of November 20th). However, just a week ago Scott Bessent’s odds for the position were sitting at 80%. Here are the odds:
Quite the group of Wall Street legends, especially as you head lower down the list. We will give a brief overview on the four leading candidates who look like they have a shot at the position.
Bill Hagerty is a U.S. Senator from Tennessee, he served as the Ambassador to Japan during Trump’s first tenure, is a long-time Trump ally, and has a consulting / private equity background. However, he has held several public roles over the last decade and a half.
Marc Rowan is a legendary investor who co-founded Apollo Global Management. Scott Bessent is the founder of Key Square Group, a global macro investment firm. Kevin Warsh is an American financier and bank executive who has sat on the Federal Reserve Board of Governors in the past. All three men have helped advise Trump or have been major donors in the past.
The group of 4 men are all Trump loyalists, no surprise. According to insiders, the 4 men mentioned above are finalists and will be interviewed by Trump and his team to fill the role. Market strategists believe Warsh is a seasoned veteran who could provide stability to global markets and remove uncertainty. Many believe now is the time for stability and a neutral Treasury secretary after Janet Yellen’s reign under Biden. Yellen has been critiqued by many as the most left-leaning Treasury Secretary in history.
A key factor for Trump and his team for this role is selling Wall Street on tariffs. He reportedly wants the Treasury Secretary to go to bat for him on this controversial policy.
We are not political experts, but we will be watching this announcement closely.
Private equity buys an American favourite
On Tuesday, it was announced that alternative asset manager, Blackstone had purchased fast food chain Jersey Mike’s Subs. Jersey Mike’s was founded in 1971 in New Jersey. The sandwich maker has 3,500 locations across the U.S., Canada and the United Kingdom. However, most of its operations remain in the U.S. Last year, the sandwich maker announced its first major international expansion plans. The company along with Redberry Restaurants announced a goal of 300 locations across Canada over the next 10 years.
Blackstone’s purchase reportedly values Jersey Mike’s at $8 billion including debt. The deal is expected to close next year. This is the most recent transaction where a private equity firm is acquiring a franchise operator. Last year, Roark Capital bought Subway in a deal worth close to $10 billion. Blackstone has been on an investing spree in food franchises this year. This year, they have announced investments in 7 Brew Coffee and Tropical Smoothie Café.
Jersey Mike’s founder and CEO Peter Cancro said he believes his restaurant chain has more room for growth and Blackstone is the partner that can help his company reach its full potential. The CEO will continue to hold equity in the company and will continue to lead the business.
The deal will reportedly have an earn-out agreement where the full deal price will be paid when Jersey Mike’s opens its 4,000th location. Roark’s deal with Subway had a similar earn-out feature.
Last year, according to sources, Jersey Mike’s brought in $3.3 billion in revenue. Reportedly each location makes $1.35 million – more than double the average Subway.
Most details on the deal have not been made public but insiders believe, the founder and CEO held onto most of the company’s shares and after this deal will become a billionaire and one of the world’s 500 richest people. Cancro started the business with a $125,000 loan he acquired as a senior in high school. He will reportedly be worth close to $7 billion after this deal, quite the return on investment.
Many on X (Twitter) voiced their concern over this recent PE acquisition pointing to PE firms purely looking for profit by cutting costs and corners.
Jersey Mike’s recent growth only trails 4 major fast food chains including Cava and Raising Canes. We do not think this growth story is over and believe there is more growth for the sandwich maker. However, do not be surprised if quality goes down, and the price moves up.
This is perhaps the last major American sandwich maker to be acquired by a private equity firm. Subway, Jimmy John’s, and Firehouse Subs have all at one time been owned by private equity shops.
Fast food companies have performed quite strongly in recent years. The poster child is Chipotle which has seen its stock surge over the last decade and a half. Most recently, Cava Group successfully went public in June 2023 and has seen its stock jump 265%. Investors are piling into these names at rapid rates. Cava Group is one of the most expensive stocks in the U.S. trading at 300x earnings. It makes Tesla, Nvidia, and Palantir look cheap. Investors are betting on huge growth prospects in these names but the slower, methodical, more thought-out growth stories have been the most successful in the industry. We hope for our sakes as consumers that Blackstone keeps Jersey Mike’s relatively the same.
This acquisition is yet another example of private equity growing as an asset class and accessing more and more companies.
MacNicol & Associates Asset Management
November 22, 2024
Click here for the PDF: The Weekly Beacon -November 22 2024
