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Where Investors Are Finding Returns in a World of Yield

The Federal Reserve’s aggressive interest-rate-raising campaign to tame inflation has upended the long-held paradigm that “there is no alternative” to stocks. After last year’s stock-market selloff burned investors, many say they don’t need to buy stocks when they can lock in a 5% return with little risk. Market participants are bracing for the potential of more interest-rate increases ahead as the economy continues to show signs of strength. Investors have yanked $11.6 billion from stock funds on a net basis over the past five weeks, while putting a net $91.1 billion into money-market funds, according to Refinitiv. Yields on most bonds are fixed, however, so holders of Treasurys still bear risks like rising interest rates or a resurgence of inflation. The yield curve is still inverted, meaning short-term bonds yield more than longer ones: The one-month Treasury bill yields 5.37%, while the 30-year bond offers just 4.38%. The advantage of the longer-dated securities is the yields are locked in for longer, in case interest rates start falling again. Cash in retail money-market funds has grown more than 25% this year to $1.5 trillion, according to Federal Reserve data. The average yield on the 100 largest taxable money-market funds reached 5.15%, according to Crane Data. That is the highest since 1999. Money-market funds, which are a type of mutual fund that functions as a sort of bank account, are as safe as the bank that offers them. They hold only high-quality, liquid assets such as Treasurys and, in some cases, short-term corporate debt. Sometimes money-market funds require minimum balances and limit monthly withdrawals. Several funds offer yields comparable to those available from Treasurys, according to Bankrate. Speculative-grade, or junk-rated, companies tend to offer higher interest rates to compensate investors for taking on greater risk. High-yield corporate bond funds can offer investors sizable income after fees, while also offering diversification to protect against credit risk. Investors have been pulling money from high-yield corporate bond funds. Roughly $11 billion has left those funds on a net basis this year, according to Refinitiv Lipper. Still, several household names, like tobacco company Altria and telecom giants Verizon Communications and AT&T, offer comparatively high dividend payouts. Companies typically pay large dividends or buy back stock when they don’t see better opportunities to invest their money in growth projects, so high dividend payers tend to be older, slow-growing firms. Payouts can rise or fall based on each company’s financial performance and investment priorities, so they are riskier yield options than a government bond.

How This Year’s Hottest Investment Could End Up Costing You

Cash has rarely been this hot on Wall Street. Financial advisers warn holding too much can burn a hole in your portfolio. With markets rocky and cash earning 5% or more, investors have boosted their holdings of money-market funds to a near-record $5.6 trillion, according to the Investment Company Institute. Both individuals and institutional investors are piling in—asset managers now have roughly one-fifth of their portfolios in money-market funds, State Street data show. Cash was trash for years on Wall Street, where low interest rates left investors buying every dip, saying there was no alternative to stocks. The prospect of a prolonged period of higher rates has upended that thinking, buffeting both stocks and bonds while increasing the returns offered by some of the safest, shortest-term investments such as money markets. Yields fluctuate with benchmark rates set by the Federal Reserve. Though considered to be among the safest of all investments, deposits in the funds aren’t insured and they have occasionally gone haywire in times of stress. The Fed’s most aggressive interest-rate campaign in decades has lifted rates near the returns many investors would expect from their portfolio on an average year. With the central bank expected to hold rates near this level for some time, money-market funds are now considered a viable investment rather than just a place to stuff cash. Fees are also relatively high. Investors pay annual expenses based on how much they have invested in a fund. Many large money-market funds charge 0.5% a year in fees, if not more, to support upkeep including administration, trading costs and employee salaries. Taxes are another consideration, and often a big one. Interest payments on money-market funds are generally taxed as ordinary income, not at dividend or capital-gain rates. How the income is taxed at the federal or state level will depend on the investments a fund holds. Interest from U.S. Treasury debt, for example, is taxable at the federal level, but not for states.

The Startup Making It Easier for Young People to Put Money on Sports

A crop of new companies are capitalizing on the demand, offering a sports-betting-like experience that falls outside of gambling laws. The tactic has drawn throngs of new users, including young adults and people who live in states where sports betting isn’t legal. Atlanta-based PrizePicks, which has attracted new users at a fast clip over the past year, says it offers fantasy-sports games, not gambling, and that it only operates in states where its products are legal. Over the past year, the PrizePicks app has been downloaded more than the sports-gambling apps for Barstool Sports and Caesars Entertainment, and it has been gaining ground on the top two competitors in sports betting, FanDuel and DraftKings, according to estimates by data tracker Apptopia. The company’s ascent has contributed to growing tension in the fast-evolving U.S. sports-betting industry, where fantasy apps and gambling companies are pursuing sports enthusiasts who are new to betting. Fantasy-sports apps are increasingly making products that are similar to sports betting, but are more lightly regulated. Fantasy sports have largely been considered by states to be a game of skill, requiring research and knowledge to be competitive. Sports betting is considered gambling as a game of chance. Gambling is regulated state-by-state, with different rules governing sports betting and fantasy sports; some states haven’t regulated fantasy sports at all. Some gambling regulators and rival companies say that PrizePicks’ model is making sports betting available to a younger audience, as well as in states where it hasn’t been legalized or regulated with consumer protections. In most states, sports betting has a minimum age of 21, while daily fantasy-sports games typically have a minimum age of 18.

Climate Risk Is Becoming Uninsurable

Floods, electrical storms and wildfires, together with raw-material inflation, are pushing up premiums for so-called catastrophe insurance. For insurers, average annual losses—a conceptual long-run estimate of future losses—could reach a record $133 billion, according to risk-assessment firm Verisk Analytics. Uninsured losses will be even higher. In North America, only 51% of natural-catastrophe risk is covered. In Europe, it is 44%, and in Asia a paltry 12%. The fear is that more areas could become uninsurable. Underwriting requires confidence that models somewhat accurately reflect risks, which climate change is amplifying in scary, unknown ways. Forecasters are starting to marry both methods, with some startups promising transformative results. Other startups specialize in disasters that are too unpredictable for many insurance policies, with protection often depending on limited government support. U.K.-based CatRisk Solutions, for example, provides an earthquake-loss model covering 155 countries. In 2020, New York-based First Street Foundation released an online application where anyone can check their property’s flood exposure. It suggested that federal maps severely underestimate risks. The rising cost of disasters is more about population increases in hazardous areas than climate change itself. Inigo’s research suggests that demographic shifts have caused more than a doubling in expected annual losses since 1970, compared with a 25% increase from climate change.

Invest in America, Live in Europe—a Mantra Some Just Can’t Shake

Even Europeans are starting to wonder why they bother to invest in their own region. The economy is stuttering while the U.S. booms. It’s an also-ran in a world dividing into blocs led by the U.S. and China. And its biggest companies wouldn’t even make the top 10 in the S&P 500. The “Magnificent Seven” big U.S. stocks are, as of two weeks ago, collectively worth more than all western European listed stocks together. The European economy may not be as bad as it seems. And European stocks are cheap, so as bad as it is, much is already priced in. There’s one pushback: Since the end of 2021, the region’s stocks have actually been pretty good. First, European stocks aren’t a very good way to bet on Europe. The market is dominated by multinationals: Successful ones include LVMH, the world’s biggest luxury-goods maker, and Denmark’s Novo Nordisk, maker of the diet drug Wegovy, as well as a bunch of much-less-successful ones, such as Volkswagen, whose shares are at the same level as in the summer of 2007. Firms in Europe’s Stoxx 600 benchmark make less than half their sales in Europe, according to FactSet data, and the U.S. is their single biggest market, at 23% of revenue. That compares with S&P 500 companies getting 59% of their revenue in the U.S. Britain is even more global, with companies in London’s FTSE 100 making more sales in the U.S. than in the U.K. European stocks are cheap compared with the U.S., especially U.K. stocks. Even adjusting for the fact the U.S. indexes put more weight on big, expensive technology companies and Europe on cheap banks, Europe is still much cheaper. Every European sector in the MSCI indexes trades at a lower price-to-earning ratio than those in New York. Compare the U.K., U.S., developed eurozone and Japan, and the U.K. is cheapest in five out of 10 sectors (I excluded real estate, where P/E isn’t an appropriate measure), the eurozone in two, and Japan in three. The U.S. is most expensive in five, Japan in three (communications, thanks to SoftBank, healthcare and consumer staples) and the U.K. in two (technology, ironically enough, where only two big London-listed firms survive, and industrials). Focusing on the fact that European stocks don’t rely on the European economy is Mortier’s favorite way to buy the region, buying globally competitive companies that just happen to be European. The problem is that everyone is doing this: Novo Nordisk, LVMH, the Dutch chip maker ASML and the airplane manufacturer Airbus, among others, are obvious leaders that can’t be ignored by any global investor. Many Europeans have been giving up on their domestically focused companies, while foreign interest is nonexistent. That has made firms outside the superstar list very cheap. For investors who like to rummage for bargains, Europe, and the U.K. in particular, is the place to look. In 2022 and 2023 combined, Italy had the best-performing stock market in the Group of Seven leading advanced economies, in dollar terms, followed by France and the U.K., thanks to outperformance by banks. Switzerland, where Credit Suisse imploded, lagged behind. True, the U.S. ended 2021 at an all-time high with many sectors having extremely high valuations, while Europe was cheap. But, umm, look at the market now. European stocks have been cheap for a while, without attracting buyers. Investors are convinced that Europe’s regulation and social support hurts profit margins. On the plus side, such support makes for some of the world’s best places to live, with four of the top-10 most-livable cities, according to the Economist Intelligence Unit (the U.S. has none).

America’s Oil Patch Loses Its Luster

The oil-field services sector is still humming along, but its clients are casting their gaze past America’s once-booming shale patch. U.S. benchmark natural-gas futures have been hovering just above $2 per million British thermal units recently, well below the $3.45 per million British thermal units that price producers say they need on average for drilling to be profitable, according to a first-quarter energy survey by the Kansas City Federal Reserve. Domestic oil-drilling activity has also been weak. The U.S. oil rig count has dropped almost every week since early February, according to Baker Hughes data. This might reflect caution and price sensitivity from private drillers, which had been quick to add rigs last year but were also quick to drop them when oil prices declined in parts of this year. After some steep cost inflation last year, break-even prices have risen for producers, according to Kansas City Fed survey results. Major international oil companies that previously held back on expensive, long-cycle offshore drilling projects have again embraced it after generating prodigious cash flows last year. Investors have become more receptive to such projects after Russia’s invasion of Ukraine highlighted the importance of energy security. Weakness in North American short-cycle activity notwithstanding, oil-field services firms’ unwavering pipeline of long-cycle contracts signal that the world’s producers, whether major European oil companies or national oil companies, are still in the fossil-fuel business for the long haul.

The Dominant Dollar Faces a Backlash in the Oil Market

An estimated 20% of global oil this year was bought and sold in other currencies as Russia and Iran sold cargoes to China and other buyers. Some major emerging economies are dabbling in trading commodities without using the dollar, as they seek to reduce their reliance on the U.S. currency. Faced with U.S. sanctions and other restrictions, Russia and Iran in particular have stepped up oil sales in alternative currencies, and have found buyers in China, India and elsewhere that are happy to buy these exports, often at lower prices. The need is less pressing for other commodity heavyweights. But some of these countries, including Brazil, the United Arab Emirates and even Saudi Arabia, have recently taken steps laying the groundwork for trade that sidesteps the dollar. Twelve major commodities contracts settled in nondollar currencies were announced in 2023, compared with seven in 2022 and just two in 2015 through 2021, the bank’s data shows. This year’s contracts were struck by sellers in Russia and, in one case, the U.A.E. The data relates to physical commodity deals, rather than the trading of futures in financial markets The U.A.E. and India signed a deal to trade in their own currencies, starting with a shipment of Emirati oil bought by an Indian refiner, and paid for in Indian rupees. Brazil and China completed their first local-currency commodity transaction, involving a shipment of Brazilian pulp, according to China’s state news agency, Xinhua. Saudi Arabia and China set up a roughly $7 billion currency-swap line, which the Chinese central bank said would strengthen financial ties and expand the use of local currencies. The dollar’s central role in commodities is one aspect of its broader dominance of global trade and finance. The dollar appears on one side of 88% of all trades in foreign-exchange markets. Controlling the most important currency has helped the U.S. act as the world’s watchdog because threats of exclusion from the dollar-based financial system have had significant weight. If the dollar’s dominance were to erode, that could eventually diminish this authority. Russian oil has been sold in Chinese yuan, Russian rubles, Emirati dirhams and Indian rupees, according to the Institute of International Finance. Russia became China’s top crude supplier in 2023, selling over 2 million barrels a day through July, according to S&P Global. Shipments were largely paid for in yuan. Moscow has also shifted major gas contracts to China, according to JPMorgan. Iran, which mostly sells oil to China in yuan, also has stepped up exports. Paying in a domestic currency rather than dollars lowers transaction costs, and Russian oil is cheaper than global alternatives. India has emerged as Russia’s biggest new energy customer, Kpler data shows, after New Delhi told its largest oil companies to snap up discounted Russian crude. They have paid in dirhams, yuan and rupees, according to Indian oil executives. Pakistan began paying for Russian oil shipments in the Chinese currency this year, according to JPMorgan. This move coincided with a dollar shortage in the South Asian country. China eclipsed the U.S. as Saudi Arabia’s biggest trading partner when the U.S. became more energy independent, and it has deepened political ties with Saudi Arabia. The dollar’s central role in oil markets might again prove difficult to shake. Even if Gulf countries use local currencies for transactions, the dirham and the Saudi riyal themselves are both pegged to the dollar.

Green Energy Is Stuck at a Financial Red Light

The wind and solar industries have always suffered from the short-term nature of subsidies, with federal tax credits often extended in nail-biting one-year increments. Last year’s climate bill changed that, giving the industry subsidies that last at least a decade. But just as policy winds blow in their favor, two critical growth drivers—interest rates and equipment costs—are moving in the wrong direction. Wind and solar projects are especially sensitive to rates because debt can comprise as much as 85% to 90% of capital expenditures. Renewable developers have known only low rates for most of their history. Nearly all U.S. utility-scale solar facilities and 85% of onshore wind farms were installed since 2009, during which period the target federal-funds rate was close to 0% in eight out of 13 years. Not any more: After the most recent hike, rates are the highest since 2007. Renewable energy projects tend to be financed with floating-rate loans that rise and fall with the benchmark interest rate. Thankfully, most of those projects are well-shielded from rate risk because lenders require them to hedge at least 75% of their loans through swaps, according to Elizabeth Waters, managing director of project finance at MUFG. Most ended up hedging 90-95% to lock in low rates, she noted. But those swaps won’t help new projects. Some new solar and wind projects facing higher borrowing costs than when they were planned might not make it off the drawing board. Borrowing isn’t the only thing that costs more. Following years of price declines thanks to technology and economies of scale, equipment is getting more expensive too. Trade policies aimed at Chinese manufacturers have caused delays and shortages for the solar industry, which relies heavily on the country for its components. German utility RWE, an active developer in the U.S., said in its annual report released last week that imports of solar modules from Asia are now subject to “stringent checks” and said it could fall behind on its expansion plans if the U.S. continues to “impede the procurement of solar panels.” After falling to a record low in 2020, the average price of a solar photovoltaic system rose in 2021 and then again in 2022, according to data from the Solar Energy Industries Association and Wood Mackenzie. Meanwhile, the average cost to build an onshore wind farm in the U.S. rose in 2020 and 2021 before leveling off last year, according to data from BloombergNEF. Supply-chain issues and interconnection delays already started slowing the clean power industry last year: In 2022 it installed 25.1 Gigawatts of total capacity, a 16% decline from a year earlier, according to the American Clean Power Association, which tracks solar, wind and energy storage. While that’s still enough to meet roughly half of Texas’ electricity demand, it was nonetheless below expectations–though part of the drop was driven by an preplanned phase-down for tax credits commonly used by the wind industry before the Inflation Reduction Act was passed. Ultimately, solar and wind’s ability to absorb cost and interest-rate hikes depends on how willing utilities and corporations are to pay higher prices. Many onshore wind and solar projects have been able to renegotiate pricing on their power purchase agreements because demand is robust, according to industry executives. But cracks are showing for offshore wind, which is more exposed to rising costs and rates because it takes longer to develop. BloombergNEF estimates that the weighted average cost of capital for U.S. offshore wind projects rose to 5.25% in 2022 from 4.41% in 2020.

Why Exxon and Chevron’s Deals Leave Investors Cold

U.S. oil majors Exxon Mobil and Chevron are good at squeezing hydrocarbons out of the ground. The companies have tried hard to be attractive, first by continuously demonstrating spending discipline and consistently doling out generous shareholder returns. Most recently, both announced mega acquisitions at reasonable prices. Exxon just acquired some of the best acreage in the prolific Permian Basin, paying a 9% premium on Pioneer Natural Resources’ 30-day volume-weighted average price as of Oct. 5. Chevron, meanwhile, added some valuable Guyana exposure, paying a 10.3% premium on Hess’s 20-day average price on Oct 20. Exxon announced a 4% dividend increase—more generous than last year’s hike of 3%. Both are still generating a lot of free cash flow and returning a good amount of it to shareholders: Exxon and Chevron have paid out $24 billion and $20 billion, respectively, in dividends and buybacks year to date. Exxon said its energy-products segment was negatively affected by unfavorable timing of its hedges, which will unwind over time. Its chemicals segment, meanwhile, succumbed to compressed industry margins. Chevron reported worse-than-expected international downstream results, which were affected by lower margins on refined-product sales and lower refinery runs because of planned shutdowns. Investors have expressed doubts about Exxon’s claim that it can produce more out of its and Pioneer’s combined acreage than the companies would have individually, all while reducing costs. In the earnings call on Friday, Exxon gave more color, saying that its method—known as cube development—delivers similar recovery on its own acreage as Pioneer’s, even though Pioneer acreage is higher quality. Cube development allows Exxon to drill multiple horizontal wells in stacked intervals from a single surface location—a method that helps maximize recovery while reducing costs. Chevron said that the project is expected to cost between 3% and 5% more than the initial plan. Chief Executive Mike Wirth said that the project has had unique issues and that remaining projects in its pipeline are less complex.

Big Tech Depends on AI Shining Through Cloud Haze

Amazon’s AWS, Microsoft’s Azure and Google’s Cloud segments generated a combined $157 billion in revenue last year. But, according to consensus estimates from FactSet and Visible Alpha, that combined revenue is expected to show 21% year-over-year growth for the March quarter—4 percentage points lower than the growth shown in the December quarter and the lowest combined growth on record for the three. The June quarter is expected to show further deceleration, with combined revenue growth falling below the 20% threshold. Amazon’s AWS—the largest of the three—is expected to increase first-quarter revenue by just 15% year over year, which would be its slowest growth on record. Operating earnings for that segment are also expected to slide by 17%, year over year. Analysts also expect record-low growth for Microsoft’s Azure of 27% year over year. Google Cloud, a little over half the size of Azure, is expected to increase revenue at only a slightly better pace of 29% for the first quarter. But the search giant might have some better news on its bottom line, at least optically. According to a filing Thursday, Google is reallocating some expenses from its cloud business to its core search segment. The reclassifications trimmed more than $1 billion from the cloud segment’s reported operating loss for 2022 and will likely help the unit tip into profitability sooner. Microsoft was the first to hop on the bandwagon, with Chief Executive Officer Satya Nadella announcing in mid-January a plan to adopt the popular ChatGPT technology from OpenAI across its products. It is too early for generative AI technology to be driving much if any revenue for all three companies, but it isn’t too early for the costs of those projects to start hitting their bottom lines. And those higher costs will come as the slumping economy compels more large companies to slow down their tech spending. Tim Horan of Oppenheimer trimmed his estimates for Amazon’s AWS and Microsoft’s Azure businesses earlier this month, noting that “enterprises are sweating legacy on-prem infrastructure longer as they take a wait-and-see approach to the economy.”

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