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Mar 15
Marquette University – Blue Team Named Winner of Local CFA Institute Research Challenge in Madison

​CFA Society Madison is proud to announce that Marquette University – Blue Team has won the local competition of the CFA Institute Research Challenge that was held on February 21st.  The team now advances to the Americas Regional where they will compete against universities from the United States, Canada, and Latin America.

The Marquette University - Blue Team consists of Andrea Blomquist, Tommy Borin, Gregory Glaab, Michael Healy, and Stephen Lane.​

The following universities competed with Marquette University at the CFA Society Madison Local Challenge:
Carthage College
Marquette University – Gold Team
UW-Eau Claire

Dr. David Krause, who serves as the faculty advisor of the Marquette CFA teams stated, "I'm very proud of the students who are participating in the CFA Challenge. Like past teams, they worked hard and delivered a quality product. This experience and the friendships established will stay with them throughout their careers. I can't say enough good things about the CFA Challenge - it is one of the very best experiential programs in academia. Best of luck to all of the teams in the Americas Challenge and we're pleased to be representing the Madison CFA Society."  ​

Each university sent a team of four to five students to participate in the local challenge. The local challenge was the first step of two for a local team to advance towards the global final in New York. The students from Marquette University will now travel to the regionals where they will match their wits, analytical skills and presentation abilities against student teams from the Americas. This year, the Americas Regional competition will be held in New York on April 23-24.   The Global Final will be held on April 25th in New York as well.

The students presented their analysis and buy/sell/hold recommendations on Duluth Trading Company.  Their presentation at the Madison Local Final was the culmination of months of research; interviews with company management, competitors, and clients; and presentation training.

Nov 05
Fuel for (Over)heating…and more of My Favorite Themes for 2018

​Tuesday, October 23, 2018

Speaker: Jeffrey Rosenberg, CFA

  • Environment in 2018 is a bit different than we've had since the GFC – may require some changes to your approach
    • High rates mean cash is a viable asset to hold for the first time in a decade
    • Volatility may be higher
    • The market will begin to worry about both growth and inflation as the cycle extends
      • Bonds can hedge growth concerns, but not inflation concerns.
    • Financial conditions are tightening as a function of fed policy
      • Risks for equities higher in that environment

  • Future Fed moves may depend on the data
    • Fed governors appear sensitive to strength in the economy
    • High inflation is still a fear as labor markets tighten, but offsets remain
      • Globalization and cheap labor
      • Ability to automate as wages grow also helps offset this

  • Biggest near-term risk is a mid-cycle rate tantrum
    • If equities go down because of inflation fears, bond holdings don't offset that type of risk – means both sides of the portfolio could be hurt
      • May need to make sure clients understand this
    • Long-term, still no signs that the market is expecting high levels of inflation, however

  • Ultimately, cycles end because of financial shocks or overheating in the general economy
    • Not a lot of signs of either at this point
    • Shadow banking system risk is increasing however – private debt issuance very high
      • Could be the place where we first see issues
    • Some chance that rates risk 50-100 bps as both inflation and real rates rise – that could be difficult for markets to handle

May 25
State of U.S. Health Care & What’s Next: Pharma Spotlight

​Wednesday, May 16, 2018

Speaker: Curt Wanek, Biotechnology and Pharmaceutical Industries Analyst, Bloomberg Intelligence.

1.   Three pillars of Pharma

  • Large pharma – mature diversified large companies, e.g. Merck &Co, Pfizer, Johnson & Johnson.
    • Challenges: patent expiration, hard to growth given already high revenues, rebate pressures.
    • Opportunities: excess cash (in a highly acquisitive pharma space), diversification, innovation.
  • Biotech companies – Gilead, Amgen, Celgene.
    • Challenges: competition/ patent expiration, rebate pressures, finding ways for the new innovative therapies to be reimbursed.
    • Opportunities: excess cash, expertise, highly innovative (with immature pipelines, however).
  • Specialty generics – Teva, Mylon, Valeant, Mallinckrodt.
    • Challenges: significant price erosion due to competition, manufacturing challenges due to delays of FDA approvals, highly leveraged.
    • Opportunities: biosimilars are the biggest frontier, complex generics, and diversification.

2.    Drug Pricing

  • Drug pricing is extremely tangled involving consumers, pharmacies and pharmacy benefits managers, wholesalers, insurance companies, and manufacturers. This "web" (including rebates and reimbursement negotiations) is a big black box as a lot of information is still not open to the public.
  • The role of rebates has been extremely growing in the past few years – the total rebates for the top 11 bestselling drugs comprised almost $33bn in 2017, or 43% of the gross sales of those drugs reported by the manufacturers (compared to $11bn and 25%, respectively in 2014), meaning that for each $100 worth of drug manufacturers were giving almost $45 back to the supply chain.
  • As a result, even though the gross sales are growing the actual net sales (gross sales less rebates) remain stagnant.
  • Branded drug prices increase at lowest on the record (just below 2-digit price increase y-o-y) due to payer, political and public pushbacks - real innovation is a key for the branded drug prices (e.g. Gilead's Yescarta, AveXis' AVXS-101, Hemophilia Gene Therapy – probably will come to the market with over $1m price).
  • Outcomes/Value based care.
    • Outcomes based care is the idea that a drug should get reimbursed based on the therapeutic benefit it provides to a patient (as not all drug work for every individual and with the current system you will pay whether the drug works for you or not).
    • It is a reimbursement of the future though it has some challenges to overcome before it is adopted widely (no standard definition of outcome etc.).
    • The payment model will thus align the clinical value of the drugs with their price.
  • Generics drug prices are falling at unprecedented rates due to record FDA generic drug approvals, rising competition, and consolidation among buyers.
    • To combat generics price erosion pharma companies build strong pipelines, produce complex generics, biosimilars (at least $130bn per year potential market), use low cost structure and diversification.
    • We think generic price erosion is probably at the bottom (mixed feelings from Pharma companies, FDA generic drug approvals may drop by more than half y-o-y in 2018).  
  • Trump's American Patients First
    • More than 50 initiatives to lower prices, increase competition, and lower out-of-pocket expenses.
    • Key inclusions: incentives to discourage price increases, indication based pricing, various price transparency measures and measures to restrict the use of rebates, promoting competition for biologics, leverage Part D negotiating power for Part B drugs etc.
    • Did not include the ability for Medicare to negotiate prices.
    • Legacy generics may continue to see pricing pressure. Biosimilars and OTC drugs may see upside.

3.    M&A: Pharma is highly acquisitive

  • Mergers and acquisitions are big in 2018 – almost $150bn worth of deals in pharmaceutical sector YTD and more to come.
  • M&A is an urgency for large players: major pharma companies (Bristol Myers, Celgene, Gilead, Sanofi, GlaxoSmithKline and others) set M&A as a top priority – while Celgene and Sanofi have already done big deals there are still more companies that have high urgency for deals.  

4.    Not all ETFs created equal

  • IBB vs XBI: A lot of overlap between the two but the equal weighting of the XBI allows it to capture more of the upside from acquisition targets.
  • Niche ETFs newly created may offer exposure to areas on the edge of science:
    • CNCR offers direct exposure to immunotherapy
    • ARKG - genomic revolution exposure

1.  Some of those drugs you mentioned are worth $1m: how will the countries/families with single payers be offered to buy them? Or will they not be offered at all?​

  • Those drugs has not yet been approved.
  • The current pricing system needs to be changed.
  • In case of no changes to the pricing system the demand for those drugs could be so low that they may not have significant impact on pharma companies' performance.

 2.  Sources of pricing pressure?

  • Generics players from India are making their way in decreasing prices,
  • All major pharma companies have to compete with decreased prices.

3. Are drug companies willing to use outcome/value based models? What are the drug costs structure?

  • PBM (Pharmacy Benefits Managers) block the initiative.
  • Reimbursement system is a big black box – no public info on how much rebate is given for a drug.
  • Rebate system will be there but in some other form - it has to change.
  • PBM models are going to be changed. Now it's a vicious circle – drug companies increase prices, PBMs increase rebates.
  • Outcome value based care is a reimbursement model of the future.

 4. Talking about margins - how much prices have to go down until pharma companies become bankrupt?

  • Depends on type of drugs and existing margins, e.g. injections have higher margins.
  • Companies have to deal with increasing competition.
  • Drug prices here are elastic.
  • Margins for some of the generic drugs are already negative.

5. One of the recent proposals is to name the price when advertise drugs. Will that have any effect?

  • Absolutely yes.
  • People may not even want to consider buying too expensive drugs regardless of potential positive effect. ​

Mar 30
UW-Eau Claire competes at the Americas Regional Challenge

​The Americas Regional competition was held on March 19-20.  In a highly competitive, high pressure environment, the team presented well and showed their comprehensive understanding of their subject company.  Even though UW-Eau Claire did not advance at the Regional competition they did an excellent job and should be very proud of the hard work they put in.

UW-Eau Claire team and Marquette University team at the Regional Challenge along with their faculty advisors and mentors.

Mar 19
Financial Regulation & Policy Outlook – A View from Washington D.C.

​Thursday, March 8, 2018

Speaker: Jaret Seiberg, Managing Director, Cowen Washington Research Group.

1.    Political environment in Washington DC.

  • Trump is controversial. However, we should admit that despite a political chaos, he achieved a lot for the economy.
  • Good news: Trump certainly has been successful. After 14 months of Trump's ruling:
    • There is no longer a traditional pro-business Republican Party.
    • There is no grand strategy in Trump's twitting – he doesn't try to distract us from what regulators are doing, he is a performer - just wants to be popular. He often attacks his own team.
    • Trump introduces a new model for President and presidency.
    • Tax bill - positive for business in the short-term.
    • Trump has filled the agencies with his people, and they are aggressively pursuing a pro-business deregulatory agenda.
    • All of these are designed on boosting GDP and getting the economy to grow faster.
  • Bad news: we are probably at the peak now. Going forward the situation will become far more challenging, and the impact on the economy far more negative.
    • The protectionist trade agenda.
    • No movement on an infrastructure bill.
    • Entitlement reform – zero progress and no White House interest in the subject.
    • Deficit cut – no progress, instead added $1.5trln (tax cut) + $500bn (increased domestic and defense budget spending).
  • Democrats may retake the House in November – need to pick up seats in California, New York and other predominantly democratic states, that are particularly hard hit by the tax cut.
  • Trump is borrowing from the future to give us stronger economic growth now. The $2bn stimulus (the tax cut and increased spending) are good for the short term but worse for the longer term. The question to ask: what policy tools are on the table if we are going for another downturn?
  • Trump will likely be a one period President by choice – he has raised about $100m in campaign contributions before he makes his decision to run for the second time, and we may see him using those money to subsidize his lifestyle.
  • If everything stays calm in the following 2.5 years, Trump has probably done enough in year one to be able to declare he'd made the country great again at the end of his term.
  • Republicans are eager to speak about the tax cut as they see the tax bill as a legacy issue that will help them to get through the next couple of elections.


2.    Macro threats.

  • Trade War:
    • Questions yet to be answered: What happens when it comes to a retaliation? Are Canada and Mexico going to be exempted? Whether Europe will be covered by the sanctions or some allies will be exempted?
    • Trump is getting "tough" on tariffs, and we do think these could be the path he cannot retreat from. If we get higher prices for steel and aluminum that will negatively affect manufacturers - users of steel and aluminum - by making their products less competitive. In terms of retaliations, the agricultural sector is the most vulnerable.
  • Federal Reserve.
    • President expects economy to grow from 3% to 5% a quarter.
    • Powell will raise rates. We may probably see 4 rate hikes in 2018 and could be even more aggressive if there are signs of inflation after all those stimulus.
    • That may lead to a twitter fight with Trump going after Federal Reserve. Federal Reserve has not been attacked politically by White House since Carter's administration.
    • Politicizing the Fed is never a good idea. However, we have the President that is more than willing to press the boundaries and we don't know how the market would react to that.
    • The risk with Federal Reserve has not yet been taken into account by the market.
  • Russian investigation:
    • We don't see a risk of impeachment, as there are simply not enough votes in the Senate.
    • Trump is a delegator – his family, particularly Jarod Kushner is at risk (due to issues related to security clearance application, secret meetings with Russian officials before the inauguration, etc), as well as some campaign staff. Mueller is going to expose all of that with his final report.
    • We think that the most controversial part of the Trump's legacy is going to be that before he leaves he pardons everybody.
  • Gary Cohn leaving – a big threat, he was the most important person for business and the economy in the White House. Peter Navarro is a leading candidate for a replacement, however we think Larry Kudlow is more likely to takeover – Trump needs a "buddy".


3.    Key policy issues in financials and housing.

  • Banking:
    • Rise of conservatives within the White House: seek 10% capital leverage level, want to separate commercial and investment banking, limit size of a bank to eliminate "too big to fail".
    • There are non-traditional policies that conservatives in Trump administration favor (e.g. Marc Calabria) and those policies could catch the market by surprise.
  • Housing:
    • Conservatives want to dramatically shrink the government's footprint in housing market – shrink the FHA Program, shrink and then eliminate Freddie Mac and Fannie Mae.
  • This week the Senate is considering the bank deregulation bill designed to help regional banks giving them more control over capital distributions, liquidity management, etc. The bill is expected to pass Senate next week, while getting through the House is expected to be a challenge. However, we think that sometime in October, just before the election, the House will pass whatever gets out of the Senate and the President will sign that near the Halloween - that makes us positive on regional banks.  



1. Do you think the Congress is going to elaborate on some issues on a bipartisan basis? Also, how they might shrink GSEs?

  • The banking bill is bipartisan – probably the most bipartisan thing we have seen since Trump got elected. A lot of other bills that you see moving in the House have a lot of democratic co-sponsors. However, that is the exception rather than the rule. Elizabeth Warren's wing of the Democratic Party sees no benefits to working with the Republicans.
  • In terms of GSEs: one idea is to bring down loan limits to 5-10% a year and keep doing that until they are insignificant; another idea is raising guarantee fees to the point where it would be price competitive to restart the private-label RMBS market. This is what officials like Marc Calabria and others in the White House are thinking about, however this is not what Congress wants – the reform will likely be done very gradually.

2. With the potential rise of conservatives in the administration there are more pressure on banks. Earlier, President Trump made a comment about bringing back Glass-Steagall. Can you talk a little bit more about it?

  • Bringing back Glass-Steagall is not an actual policy – Trump may actually have no idea about what Glass-Steagall does.
  • If the White House pursues the so called 21-century Glass-Steagall Act they will seek to force bigger banks to get rid of their trading desks. They might also push the banks to separately capitalize units in a holding company, but that would be too radical and would dramatically change the economics of the business. We may see E. Warren forming an alliance with conservatives to vote for the very populous idea of bringing back Glass-Steagall Act - it is one of the big threats.
  • Never overestimate the actual understanding of any of these issues on Capitol Hill.

 3. How do you see Paul Ryan's future?

  • Hope it is still possible for him to run for President – his mistake was not running 2 years ago.
  • If the House stays Republican he may not survive as a Speaker.

​​​​4. Can you comment on Infrastructure bill?
  • We are very pessimistic on it - there is no way to pay for it. They are relying on a very controversial idea of reforming Fannie and Freddie as a way to get $200bn to pay for infrastructure.
  • Trump's idea to provide incentives for a private sector to build more toll roads and to charge for these infrastructure is not politically popular.​
Mar 05
2018 Global Financial Market Outlook

​Wednesday, February 21, 2018

Speaker: Bill Stone, CFA, CMT, President, Stone Investment Partners LLC

1.    Recent volatility in the market.

  • In 2017 the market volatility was abnormally low with S&P500 intra-year drawdown of only 3%. Historical data (since 1945) suggests the average ("normal") drawdown of 14% and return of 8%.
  • Historically, after such a low drawdown the next year has always been worse in terms of volatility, while the next year's market performance was mixed but positive on average.
  • The very recent drawdown that we saw was 10.2%:
    • The market had to deal with yields moving up.
    • The bank index outperformed the market posting an 8.9% decline – banks were trading well because they benefit from higher yields.
    • The market therefore is trying to discount higher yields, but doesn't seem to think that the economy will give in.


2.    Global economic backdrop.

  • Looking at the global economy it is hard to be negative – the projected 2018 GDP growth is 3.5%:
    • Developed market 2018 GDP growth is projected at ~2.5%.
    • Emerging markets expect to see over 5% GDP growth in 2018.
    • US 2018 GDP growth is estimated at 2.5%-2.6% y-o-y.
  • We see manufacturing PMIs across the globe are better than they were a year ago – all above 50 implying an expansionary economic activity. Historically, PMIs correlate with GDP growth (except for China).
  • No signs of recession at least this year.


3.    Earnings and valuations of stocks.

  • Earnings growth has been strong around the world: in terms of 4Q17 earnings, the S&P 500 companies are running with 15% y-o-y growth, Europe and Japan – both posted 17% y-o-y growth.
  • Since the beginning of the year, we see every sector of S&P500 increased its 2018 earnings estimates to currently estimated 18.5% y-o-y growth for the index (vs. 11% y-o-y growth estimated at the beginning of the year) – part of the increase is due to the fact that tax cut was not yet priced into the analysts' forecasts at the beginning of the year, however, that increase wouldn't be the case if the economic growth didn't continue to look solid.
  • Interest rates do matter for valuations:
    • Current S&P 500 is valued at 17.3x 2018 P/E (given $157 consensus earnings estimate) vs 10Y average P/E of 15.4x. and some could argue that it is overvalued.
    • Let's look at their relative valuation to bonds. Historically, the earnings yield on S&P500 has been lower than Baa corporate bond yields on average by 150bp since 1960, and by 100bp since 1988. Based on 2018 earnings estimate, currently stocks yield about 5.8% which ~125 bp above the Baa corporates yield of 4.53%.
    • Taking current Baa corporate yield as a starting point and subtracting from it the average historical difference of 100 bp we arrive at a hypothetical earnings yield of 3.5% that implies 2018 P/E estimate of 28.6x and S&P500 value of 4490 (given the consensus 2018 earnings estimate of $157) – 65% upside to current value, way too optimistic.
    • Setting the earnings yield equal to current Baa yield gives P/E of 22x implying S&P500 value of 3454 - 27% above current market value.
    • Setting the earnings yield 1pp above the current Baa yield to 5.5% (thus giving Baa yield a room for 200bp increase) produces P/E estimate of 18x implying S&P500 value of 2826 - 4% above current market which seems more realistic.
    • Therefore, stocks do not look over valued to me. Buffet: "Stocks are not richly valued relative to interest rates".
  • Tax reform is a big deal. However we should be careful about the amount of tax reform related increase in cash flows to put into valuation models – some of the increase may be offset by relaxed margins (due to tightening competition) and/or higher labor costs.
  • S&P500 Valuation & Inflation - multiples are set to fall with growing inflation.
  • Current inflation, yields and tax rates are favorable for stocks valuations compared to historical averages.

4.    2018 outlook.

  • Global economic growth should continue into 2018.
  • Fed is expected to rise rates 3-4 times which should move bond yields upward.
  • Volatility likely to continue relative to 2017.
  • 2018 earnings look solid + additional tax reform upside.
  • We are anywhere close to recession – overheating (I don't see it yet) + external shock (e.g. oil price, but oil prices at this point are not in the risk area).
  • Geopolitically – impossible to predict. No action is the best choice - most of the time the market starts recovering in about 20 days after the shock event.
  • Be aware of the bond proxies in the equity markets.
  • International markets still look attractive in terms of prices relative to the US market - in particular, very positive on Japan.

5.    Bitcoin.

  • As for me, bitcoin is a speculation not an investment. I define investment as something with positive expected return after inflation. Bitcoin is essentially a currency, and generally speaking, over the history currencies have not been a good investments. I don't know any currency (except may be Japanese yen at some point of time) with positive expected return after inflation.
  • We believe in a blockchain - it has some other important implications for investments.
  • Highly recommend Netflix documentary "Banking on Bitcoin" for those who are interested in cryptocurrencies.



1. ​You mentioned you didn't see a big recession risk in the near term - does that give you a reasonably high confidence that 2019 represents another positive year? In that sense, what kind of growth rate do you expect in 2019?

  • Feel pretty positive about 2019 in terms of economic growth – it is too early to say that with confidence though, as it depends on how the economy will perform this year (e.g. overheating, shocks are hard to predict).
  • We expect another year of corporate earnings growth next year.
  • We watch if we see enough wage growth that starts to cut into margins as labor market has become so tight. If we see wages growth, then companies would most likely spend more on CAPEX, particularly on technology to increase productivity and decrease labor costs. In that view, we are optimistic on the technology sector, which at the moment does not seem too overvalued (compared to S&P), but tech companies should have a tailwind from the CAPEX spending growth.


2. You mentioned those 3-4 potential rate hikes in 2018. Can you talk about what makes it lean towards 4 times and what are the implications in terms of potential policy mistakes?

  • The 2-year Treasuries have moved up which could be a signal that the market has already priced in those 3-4 hikes.
  • I am worried about potential policy mistake when there is an inconsistency between what the Fed says and the market movements, which is not the case this time.
  • The hikes have also been supported by the recent economic growth.


3. Do you see any bubbles or potential bubbles out there?

  • The definition of bubble to me is when valuations get so high when they stop making any sense.
  • Bitcoin certainly has some features of a bubble, however I don't know how to value bitcoin (as it has no cash flows), so it is hard to say whether the valuation we have seen is over its fair value.
  • Usually the real bubbles have an underlying truth: e.g. tech bubble – the underlying truth was that the Internet changed everything, however tech companies' valuations were a bubble. Same thing is with bitcoin: I think blockchain is going to be a changer for a lot of things, but it is unclear whether it will show up in a price of bitcoin.

4. Let me expand that bubble question. We have European government bonds in negative yield territory – doesn't it feel like a bubble? Is it sustainable for them to have negative nominal yields?

  • It doesn't seem to have a lot of sense to me either.
  • The difficulty to call current bonds valuation a bubble lies in a fact that they do end up maturing at a par value and I cannot imagine how one can make a lot of money from the other side of it.
Feb 23
UW-Eau Claire Team 2 - CFA Society Madison 2018 Research Challenge Winner

​CFA Society Madison announced today that UW Eau Claire – Team 2 has won the local competition of the CFA Institute Research Challenge and now advances to the Americas Regional where it will compete against universities from the United States, Canada, and Latin America.

The UW-Eau Claire – Team 2 consists of Ryan Battist, Chad Glover, Kyle Kolb, and Brock Schauer.

The following universities competed with UW-Eau Claire at the CFA Society Madison Local Challenge:
      Carthage College
      UW-Eau Claire – Team 1
      Milwaukee School of Engineering

Each university sent a team of four to five students to participate in the local challenge. The local challenge was the first step of two for a local team to advance towards the global final in Malaysia. The students from UW-Eau Claire will now travel to the regionals where they will match their wits, analytical skills and presentation abilities against student teams from the Americas. This year, the Americas Regional competition will be held in Boston, MA on March 19-20.   The Global Final will be held on April 25-27 in Kuala Lumpur, Malaysia.

The students presented their analysis and buy/sell/hold recommendations on Marcus Corporation.  Their presentation at the Madison Local Final was the culmination of months of research; interviews with company management, competitors, and clients; and presentation training.

Feb 21
Opportunities & Pitfalls in the Credit Markets

​​Thursday, February 8, 2018

Speaker: Bennett Goodman, Co-Founder, GSO Capital Partners and Senior Managing Director, The Blackstone Group

1.    GSO Capital Partners overview.

  • Blackstone's global credit platform with over $97bn in assets under management – one of four Blackstone's principal investment businesses.
  • Focused primarily on non-investment grade corporate credit market (Junk-rated Universe)
  • Credit strategies: direct lending, stressed/distressed debt, mezzanine lending, long only (high yield and leveraged loans), event-driven, and energy-focused funds.
  • Less liquidity does not necessarily mean increased credit risk.


2.    Market outlook

  • Short-term (1-2 years) outlook is generally constructive:
    • Favorable macroeconomic outlook due to tax reform, lighter regulatory touch, repatriation of capital from overseas, employment is high.
    • Expect 2.5% - 3.0% US GDP growth.
    • US consumers are in good shape.
    • Public markets remain open and liquid.
  • Longer-term outlook gets hazier. In our view, the main risk to the markets has less to do with macroeconomic risk but more with trade policies and in particular geopolitical risk.
  • Markets are fully valued – 8 out of 10 major stock indexes around the world have P/E multiples that are higher than their 15-year average. We view that valuation as a source of collateral protection.
  • The artificial stimulus of accommodative global coordinated easing monetary policy is creating distortions.
    • Currently the US 2-year Treasuries are traded at 2.12% YTM well in excess the main European countries as ECB buying sovereign debt building its balance sheet – here we see a potential for a broad change in the next couple of years.
    • Currently European unsecured high yield bonds trade at 3.7% yield, while US senior secured bonds trade at 6.3% - our advice: short European high yield go long US senior secured debt.
    • The spreads are also impacted – today a typical leveraged loan trade at 420bp over the Libor (vs 15-year average of 530bp); high yield bonds are even more pronounced trading at 390bp over Treasuries (vs 600bp).
  • Default rates has been pretty low since 2011 and may remain low into 2019 - JP Morgan's forecast of 2.5% default rates is well below the historical average of roughly 4%.
  • Given the historical data, we suspect the next distressed cycle is likely to come over the next few years.
  • Historically (over the past 17 years) high-yield bonds provided attractive returns in 12-24 months period after the high-yield spreads crossed 700bp, averaging to 8.0% and 22.2% return in the next 12-month and 24-months period, respectively.
  • Liquidity in the leveraged finance markets:
    • Ever since the financial crisis the capital allocated to market making has evaporated – comprised a tiny 0.3% of $1.27trln market as of end-2017, down almost 90% in volume since the crisis.
    • At the same time the HY market size has doubled (from about $0.6trln in 2008) over the same period of time.
    • We expect that situation to change, and expect the liquidity to be provided not by the largest players, but those investors that have capital to put to work when that change happens.


3.    Where are the opportunities?

  • Direct lending - senior secured loan to a middle market company can provide an attractive alternative to public markets:
    • Higher levels of income compared to many traditional fixed-income investments - yield 8%-10% vs 6.3% leveraged loans.
    • We typically got lending with 2.5x interest coverage, 1.5x interest coverage after CAPEX, less debt/cash flow multiple compared to public market deals. We got covenants!
    • Relatively low interest rate risk due to floating rate structure.
    • Relatively low credit risk due to seniority in capital structure.
  • Energy
    • Banks reduce their exposures to energy sector due to regulatory pressure.
    • Additionally, the market 'hates' E&P right now: energy stocks trading close to 52 weeks low, every energy IPO done in 2016 is trading below its issue close despite the fact that oil price has increased.
    • The capital availability for energy companies is constrained - that is generally a good time to think about investing.
    • At the same time the capital needs are accelerating: CAPEX for shale gas companies, M&A activity is picking up.
    • Hard assets, divisible acreage, optimistic CEOs and multiple strategic buyers in any given shale gas play.
    • In middle market we are focused on senior secured debt (more defensive), in energy sector we don't mind having more junior position - we can structure a convertible debt or preferred warrants where we get equity like returns but take credit type risk.
  • Mazzanine lending.
    • In 2017 we allocated $1bn into our mezzanine fund but ended up with more than $2bn worth of deals all at a very good terms.
    • Large scale capital commitments are scarce – very limited number of institutions can write a $1.0bn check today.
    • Sellers of assets need certainty of funding – the seller will not take you seriously unless you have committed funding.
    • Mezzanine financings provide speed of execution and certainty (no need for roadshows or rating agency presentations).
    • In return, a provider of mezzanine financing gets well compensated – in our mezzanine structures we are commanding 9%-10% coupons at a time when high yield bond market is yielding 6%-6.5%. Current illiquidity premium of 350-400bp is well above the historical norm of about 100bp – this creates an incremental return without increasing credit risk.
    • We are able to mitigate risk better by negotiating credit agreements. 

1. With regard to the energy sector you have talked a lot about producers, what do you think about pipelines?

  • We like midstream MLPs because they are hard assets, they operate with long-term contracts, and they are basically a unique monopoly.
  • Most MLPs trade around 7.5%- 8% dividend rate which is excessive compared to utilities' 2-3%. The growth prospects for midstream MLP pipeline companies are far greater than for utilities.
  • There is a probable $800bn of capital needs for additional pipelines given the development of shale gas in the United States. Those CAPEX projects have an average 12% rate of return. MLPs cost of capital is about 7%-8%. The industry thus provides the volume and a good risk-reward opportunity.
  • Why are they trade the way they trade? MLPs are dominated by retail investors and they tend to trade MLPs based on oil price trends; in 4Q17 we also saw a tax related selling. We believe the institutions will eventually come in to that assets class and the excessive dividend yield will come down.
  • Drawbacks: complexity of partnerships, tax consequences.

2. You gave a lot of examples about the kind of premium you were able to command over the public markets because of the features that you offer to the issuers. But at the same time one of the trends that we have observed is an increased allocation to private equity and private debt space. In theory that would mean more competition. Can you talk a little bit about the challenges and how the marketplace within the private space has changed as we have seen the growth in capital flows towards that space?

  • Indeed, a lot of capital has been raised through a direct lending around the world, and the market has become more competitive, e.g. our Libor+7% pricing was Libor+9% three years ago, a lot of deals are Libor+5% or Libor +6%.
  • In order to be in the space you have to have a competitive advantage:
    • We believe scale matters.
    • We offer to any of the company we are lending to participate in Blackstone Group Purchasing Program which negotiates better pricing for different products and passes that advantageous rates to our borrowers (e.g. Blackstone is the second largest user of Fedex services after Amazon).
    • We compete on who is the most valuable partner – on average every portfolio company that signed up to participate in that Group Purchasing Program saves 2%-6% in EBITDA annually through the cost saving.

3. What do you think about emerging markets debt?

  • We don' like it. Mostly because we don't understand it.
  • That is an incredibly different business: main difficulties are sovereign risk, the notion of a lack of a law, currency risk etc.
  • It is a different story for EM equity where you can buy a growth story. As for credit, the risk and reward (high single digit coupon) that you get are incomparable. 
4.  In direct lending how do you feel about your competitors underwriting standards?

  • Our principal competitors are "good players", but there is always someone (in any industry), likely a new entrant, who wants to "break the rules" trying to establish a market share.
  • Culture is very important.
  • Having everyone share a perspective on risk and reward is the key.
  • Stay disciplined to your core tenants.​

5. When do you think deleveraging will occur? What do you think of government loosening regulations on financial institutions?

  • I believe that many aspects of Dodd-Frank Act will either be amended or repealed. Trump's administration is very focused on getting the banks lend again with the biggest emphasis on a "local community bank" that suffered the most from imposed regulations (as they did not have resources to absorb compliance costs). Government is focused on loosening regulations to get local community banks back to having double digits ROE. I don't see the regulatory changes to have dramatic effect but on a margin it would be better for the banking community.
  • Concerning deleveraging, it is hard for us to define what is going to cause a lot of selling pressure in the next couple of years. If I had to pick one area it would be the high yield market. Structurally it is comprised of mutual funds and ETFs that provide daily liquidity to their investors. As rates go up, prices go down, you start seeing loses in high yield bond funds, and that could accelerate selling pressure. In the last three weeks, as we saw interest rates move up we did not see prices deteriorating that much in the high yield bond markets, however the redemption report showed a $2.7bn outflow from the market which caps yet the third week in a row when we see $2-3bn outflows.

Jan 25
Duluth Trading Company – An Overview from the CEO

​Tuesday, January 16, 2018

Speaker: Stephanie L. Pugliese, President and CEO

1.    Duluth Trading Co as a brand -

  • Our customers are men and women who are hands-on, value a job well done and are often outdoors for work and hobbies.
  • The brand was founded in 1989 by two brothers-carpenters in Duluth, MN who invented the Bucket Boss, a soft sided tool carrier/organizer. In the next 28+ years the company invented and brought to the market a number of new product concepts that "solve the problem": from Buck Naked underware to Fire Hose workwear, becoming a nationwide retailer.
  • Business model: majority of business is done through direct channels to consumer (phone line, website, ~ 70% of 2017 total sales) and retail (31 stores as of end-2017, ~ 30% of total sales in 2017).
  • We own our channels (only website, phone call or store), which allows us to have direct relationship with our customers and gives an ability to take advantage of full margins.

2.    Three brand pillars - 

  • Solution-based design.
  • Humorous and distinctive marketing.
  • Outstanding & engaging customer experiences.

3.    Growth strategies - 

  • Build on brand awareness to continue customer base growth.
    • Advertising (TV, digital, catalogs) takes the largest share of total marketing expenses and accounts for about 20% of Duluth total sales.
    • Retail store expansion adds to brand awareness.
  • Extend retail store base and increase retail sales – now comparatively small part of our business (~35% of total sales in 3Q17) but rapidly growing.
    • Duluth Trading added 15 new stores in 2017 to 31 total number of branded stores by the end of the year. The company anticipates opening 15 more new stores in 2018 and sees a potential for a total of ~100 stores in identified markets.
    • In first twelve months of operation a new store attracts about 40%-50% of new customers.
    • Brand awareness is considerably higher in a market with operating store(s) increasing both retail and direct sales.
    • Average store has about 10,000 - 12,000 sq feet, CAPEX ~$2m, pre-opening expenses ~$0.6m, starting inventory ~$0.6m, and a payback period of less than 2 years.
    • Logistics and well-tuned retail team make sure that as we open new stores they will continue growing along that successful path.
    • Store strategy – renovations, build to suit, iconic restorations.
  • Create deeper and longer standing relationship with our customers through serving their needs while growing Women's business and broadening assortment in Men's categories.
    • Women's business is fast growing (+35% y-o-y in 2017) accounting for 23% of total sales or about $100m in 2017 (compared to only $4m eight years ago).
    • Continue to grow through customer acquisition and new product offerings (e.g. initiating Men's business line).


1. You’ve talked about using retail stores as a base to build brand awareness and help convert people to first time buyers. When I look at the store map it seems to make sense in all the markets except for Wisconsin where you have a reasonable density of stores. Is Wisconsin an anomaly or the density of the stores in this state represent an attempt to ultimately be across all of your key markets? 
Some of the density in WI is explained by our historical ability to expand into certain stores trying new concepts in easily controlled locations and is not connected with the population density (as it is in other states going forward).
The positive sides of WI stores are: well done, payback is fast, good payoff.
We are learning how far customers are coming to reach us at certain locations.

2. How many SKUs are you managing? How do you manage them?
There are about 14,000-15,000 of active seasonal SKUs. About 70%-75% of our assortment carry forward.
In terms of management – every season our merchants analyze the core productive SKUs (“brand ambassadors”) looking for opportunities inside (color, size assortment etc) and right outside of the core, clean out unproductive SKUs (clearance events). 
Capture customer information and their shopping habits (from both direct and retail sales) and make decisions on what to sell and what to keep.

3. What is your customer demographics compared to customer demographics within your top markets? Is your customer getting older? What makes your brand relevant to younger demographic?
Going into a new market look at “our customer” density in that market. The average Duluth customer age is 54 years. It is 3-4 years younger for in-store customers and customers coming from the national advertising.
We do not chase millennials rather try to attract customers by solving a problem (e,g, No yank-tank).

4. Where is your product manufactured? Do you project cost going up? Is there going to be a bottleneck in you plans to scale up?  
Majority of our products are manufactured in Asia. We have long standing relationships with our primary manufacturing partners across multiple countries of Asia which gives us an ability and flexibility to navigate through any sort of challenges in manufacturing base. We dual source almost all of our core products so that we don’t stuck one way or another.
We purchase our products in US dollars, exchange rates could potentially have influence on us but we have not seen that issue in the past year. Moreover, because we are growing we can even see our manufacturers investing in themselves providing better cost of goods.
About 20% of products (e.g. leather accessories etc) are manufactured in the US.

5. How you ensure your associates maintain their passion and stay engaged and enthusiastic as you are?
Out of total 2500 Duluth employees across the US, about 200 are office workers and the remainder is ~ equally split between stores stuff and the customer support call and distribution centers.
Our office stuff, distribution centers’ and call centers’ leadership meets on a monthly basis to discuss business issues. Our store managers come in to our Mount Horeb office for management meetings on a quarterly basis. 
There is a continuing back and forth of communication between the offices and different parts of business (anonymous mailboxes with questions and suggestions, regular meetings, CEO visits stores etc).
6. What was the decision process to open office in Mount Horeb?
Steve Schlecht, our executive chairman and our primary shareholder, started his original business Gempler’s in Mount Horeb in 1980s and then moved to Belleville in 1997. In 2010, Duluth opened a store in downtown Mount Horeb. Three years ago the company opened Innovation Center in village’s downtown where Duluth’s marketing, creative and merchandising jobs are located. So when Duluth realized that it had outgrown its Bellville office, Mount Horeb was a natural choice to move the company’s headquarter. 

Dec 04
Making Sense of Uncertainty

​Thursday, November 9, 2017

Speaker: David Lebovitz, Global Market Strategist, J.P. Morgan

1.    Global Growth Outlook.

  • Global economic growth continues to look solid - the global Purchasing Managers' Index (PMI) for manufacturing suggests a "synchronized global economic expansion" starting fall of 2016. We observed the acceleration of growth across the developed markets and stabilization of growth in the emerging markets.
  • The reflation is in the process of running its course and has not yet come to an end. We see a slight acceleration in global economic growth in 2018.
  • The key takeaway – the ongoing trend suggests it continues to make sense to lean into risky assets, to maintain exposure to various parts of the global credit markets as well as to equities.
  • US Market:
    • The average annual US real GDP growth over the past 50 years was 2.8%. Since June 2009 the real economy growth has averaged to 2.2% annually.
    • The potential economic growth is a variable of growth in the labor force and growth in productivity. In the current economic environment both these variables are under pressure which led to a lower estimate of potential economic growth – the growth around 2% is now considered sustainable.
    • Given that currently the economy is growing in line with its growth potential, we believe that this could be one of the longest economic expansion on record.
    • The recession is unlikely in 2018-19 – key growth drivers (e.g. consumption, government spending, and investments) are in relatively good shape.
    • There is an upside risk to our base case scenario of 2% economic growth, but we think that levels of growth higher than estimated potential are not sustainable in the current economy and periods with 2.5%-3% economic growth will be followed with cooler economy afterwards.
  • European Market growth drivers:
    • European economy has been growing robustly at around 2% over the past few quarters (vs. estimated potential of 1.0-1.5%).
    • What drives the growth? Is strong EUR is a risk? What is going to keep this expansion growing?
    • Strong EUR is not a risk (or not quite yet) to the ongoing growth – strong domestic demand (rather than exports) suggests that this is an internally generated recovery.
    • The employment rate in Europe is still below its full employment level (current unemployment rate of 8.9% is above the threshold of 7.0-7.5% consistent with the full employment level) implying there is still a room for economic growth. In contrast, the US economy is currently running at its full employment levels (with unemployment rate of 4.3%).
    • Demand for credit is healthy and we see a continuation of credit growth across the Europe.
    • Given all the above, we are optimistic about potential returns from the European stocks in the next 12-18 months.
  • Emerging Markets (EM):
    • There is a statistically significant relationship between the growth in EM growth premium (the difference between the consensus GDP growth between developed and emerging markets) and the outperformance of the emerging markets equities relative to their developed market counterparts.
    • In the past 12 months we have been seeing a growth in the EM growth premium. Moreover, better economic growth has passed through into better economic profits thereby providing a fundamental support for the equity performance that we are seeing across the EM.

2.    Federal Reserve and Monetary Policy.

  • Both Fed and market are expecting the third and final (for this year) increase in federal rate in the upcoming December.
  • However, there is a gap in expectations between Fed and market looking forward into 2018-19. Similar dynamic was in 2015 and 2016 and led to uncertain and vulnerable market environment.
  • Newly appointed Fed Chairman Jerome Powell is a "market friendly outcome". We do not expect change in Fed rates trajectory.
  • Beginning of October the Federal Reserve has started a balance sheet reduction program which allows a $10bn/month run-off of government securities ($6bn of Treasuries and $4bn of mortgages) from its $4.5 trillion portfolio. The program presumes a terminal run-off rate of $50bn/month or $600bn/year of maturing assets which is nearly in line with the federal budget deficit.
  • As a result, the source of price insensitive demand, e.g. the Fed, which has been present in fixed-income markets for the past decade, is finally beginning to step back. Therefore, we expect the interest rates to grow, estimating a 10Y Treasury yield at around 2.50-2.75% by the end of 2017, and expecting it to reach 3% by the end of 2018.

3.    Investment Opportunities.

  • Fixed income.
    • Rising rates => fixed income is going to be more challenging than it has been in the past 35 years.
    • Rethink allocation – embrace opportunities both domestically (core exposure) and abroad (developed markets AND emerging fixed income markets).
  • Equities.
    • In contrast to fixed income market, rising rates should not be challenging for equities – historically, when yields are below 5%, rising rates have been associated with rising stock prices.
    • The 5% (historical) threshold could be biased upside, the "magic number" is around 3.5%-4% threshold.
    • Given the current 10Y Treasury yield, we believe there is a plenty of room for the interest rates to rise before they begin to negatively impact the performance of equities.
    • Within equities, there are favorable opportunities outside of the US with EM equities returns looking the most attractive going forward.
    • In our long term forecast, we expect some steady depreciation of $ going forward.
    • Data from the past 35 years suggests: volatility is normal, volatility should be expected, but the equity market is resilient.
    • We believe that the right investment plan remains the one with diversification. Historical data suggests that over the past 15 years the return on Balanced/Asset Allocation portfolio has over performed the return on S&P500 portfolio and it has done so with about 2/3 of underlined volatility.


​​​​1.  Why is there a difference between the US and European full employment rates?
  • Europe has structurally higher unemployment rate due to set of rules and social regulations in place – it is far harder to hire and fire people in Europe than in the US.
  • The silver lining is that there is still a room for employment growth in Europe which should help it to continue expanding above its potential over the coming course.  

​​2.  You started with the premise that the housing is the largest source of equity for households, and some could argue that the Fed has spent most of its QE1, QE2, and QE3 trying to shore up the housing market after the last recession. However, it seems as though the current administration, at least the House, is crafting fairly punitive measure for homeowners (in terms of taxation), at the same time the Fed may likely do things that increase the interest rates on the long end thereby raising the question of housing affordability. Is the future of housing one of the factors that can lead to slowdown in the economy?
  • We can see people picking up on housing because there has finally been a softness in the housing market over the course of this year.
  • In terms of housing affordability – the Fed raising interest rates on the short end will not necessarily do all that much to the long end of the curve. The rates will need to move a couple of hundreds basis points higher in order to see the affordability deteriorating.
  • In terms of new tax plan and its impact on housing market – the Senate version differs considerably from the House's initial proposal and most probably anything we end up with on the tax reform is going to be far different than what the House initially proposed. ​

​​3.  Does JP Morgan have a view if we would see corporate tax release passed before the end of the year or sometime in 2018?
  • The consensus view is that we will see some tax cuts at the beginning of next year which will likely be applied retroactively if it happens sometime in the first quarter of 2018.

​​4. Is there a way to get ahead of an asset bubble/assess a probability of seeing an irrational reaction? What about equity roll off in the next year and few months?
  • Better 5 and 10-year numbers could lead a retail investor, which tends to be a big swing factor when it comes to asset bubbles, to participate in the way that has not been the case up until this point.
  • Sentiment, enthusiasm, and exuberance are very hard to quantify. Therefore, JP Morgan is particularly focused on earnings and fundamentals as drivers of our investment views.
  • We prefer to employ some caution and be positively surprised: e.g. our forecast for US equities estimates 7% earnings growth, and that does not take into account any change in taxes, if we get a tax cut that bumps the earnings growth up to 11-12%. ​
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