What I Care About This Week | 2021 July 26

Photo by eberhard grossgasteiger on Pexels.com

by Franklin J. Parker, CFA

The Summary

  • It is Fed week! The Federal Open Market Committee meets on Tuesday/Wednesday, and is expected to announce their monthly rate decision on Wednesday. The expectation is for no rate move at this meeting, but it will be the commentary and press conference from chairman Powell that markets will watch with baited breath. Investors are eager to hear the timing of the Fed’s end to money-printing, which the Fed has so far been unable to give.

  • Earnings continue, and the news is generally good. About 100 of the S&P 500 companies have reported earnings for Q2, and almost all of those have beaten their earnings expectations. Earnings growth over last year is expected to be around 75%, which is very good. Of most interest to investors, however, is earnings guidance from CEOs, which has been largely suspended since the pandemic began. Only a few companies have even given guidance for Q3, but of those most of the guidance has been positive. The resumption of earnings guidance would be a signal that things are returning to normal—itself a positive sign.

  • This week is a pretty heavy data week. We continue to get corporate earnings, the Fed will be watched closely, durable goods orders post and will give some indication of the health of supply chains and corporate confidence, initial jobless claims will signal whether the pandemic is still dragging on employment, and consumer spending figures on Friday will give us a read on whether the consumer recovery is still in effect. In all, this is a busy week!

The Details

What are SPACs, and should you invest in them?

SPAC is an acronym for Special Purpose Acquisition Company. SPACs have been in the news over the past couple of years as their popularity and successes have gained momentum. They are a very simple construct: essentially the SPAC sponsor (usually a group with some specific industry knowledge) raises investor money by listing an empty company on an exchange. The investors do not know which company will be acquired, only that they trust the SPAC sponsor enough to pick one.

Once the SPAC sponsor identifies a target company, they use their cash to purchase the private company and the private company is now publicly traded.

The advantages to the private company are pretty obvious: they do not have to go through the hassle and expense of a more traditional IPO offering. Thus, they can exit sooner than they otherwise would. The SPAC sponsor usually retains significant ownership in the public shares, plus they get paid an ongoing management fee, and the investors get to own a company that would normally still be closely-held at that stage.

One high-profile example was the 49%, $800 million, stake taken in Virgin Galactic by a SPAC called Social Capital Hedosophia Holdings. This SPAC was put together and sponsored by silicon valley venture capitalist Chamath Palihapitiya.

SPACs, then, are a bit of a blend between public stocks and private equity (or venture capital). Because of that blended nature, investors should not think of SPACs as part of a typical stock portfolio. SPACs should receive only capital that is earmarked for higher risk investments. That is not to say that they cannot be part of an overall portfolio, rather, investors should not view them as some magical thing that reliably generates cash.

Just like any other investment, due diligence and a clear understanding of the risks are warranted.

Chart of the Week

This week’s chart comes from FactSet and shows the average size of earnings beats by sector. The financial sector has seen the largest upside surprise, followed by Consumer Discretionary. The results of financials have surprised me a bit—with interest rates near 0%, it is very difficult to earn profits via traditional banking. To that point, much of the earnings growth in the big banks has been through capital markets work: bringing companies public or underwriting debt, etc. Regional banks, however, do not have those luxuries and have been squeezed in the recent market environment.

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