Dan Zwirn, CEO and CIO of Arena Investors, returns to Real Vision to provide a strategic update on the world of credit. In this interview with Real Vision’s managing editor, Ed Harrison, Zwirn explains how, in a world of suppressed interested rates by monetary authorities such as the Federal Reserve, companies that are effectively underwater nevertheless manage to secure financing at attractive rates. Harrison and Zwirn discuss this phenomenon of “liquidity without solvency” in depth, comparing the ongoing fervor in AMC Entertainment Holdings to Hertz last summer.
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Ed Harrison's discussion with Max Wiethe in today's (27 Jan) Daily Briefing is a classic. One of the issues that came up in the course of the discussion, and again in the comments section, was the extent to which the recent madness surrounding GME, AMC, BB & BBB is driven by good old-fashioned animal spirits, and the extent to which it is a backlash against intergenerational inequality.
Here's my two cents' worth.
There is simply no way the WallStreetBets (WSB) generals could have marshalled their troops with such effectiveness, and unleashed the barrage of market-moving firepower with such relentless accuracy, if there wasn't an overarching narrative. This was financial warfare at its absolute finest, and you can only get the cannon-fodder to charge over the top of the trenches if they believe they are on the side of righteousness.
The portrayal of Gen Z and the Millennials as a bunch of feckless nihilists who are interested only in material gain is a convenient way to try and rationalise what happened with GME, but it misses the deeper issue. They deliberately targeted the shorts, not just because the WSB capos have evolved into sophisticated market operatives, but because they wanted to take out a couple of the apex predators of the Wall Street food-chain, as a warning shot across the bows.
The message was, "we just killed some of your most sophisticated operators - notice has been served". Did the System pay attention?
Its reaction was predictable: mobilise the regulators... (More)
The calculation of the discount rate used to discount cash flows in a DCF model starts with the risk free rate. This is usually the 10yr UST (if discounting dollar cash flows). This risk free rate is the starting point for both the cost of equity and the cost of debt (the weighted average of these gives you the Weighted Average Cost of Capital which is the discount applied to discount unleveraged free cash flows).
If UST yields go down (risk free rate down), all other inputs being equal, the WACC goes down and therefore future cash flows are more valuable. And vice versa.
This is a simplistic explanation of the comment “It’s the DCF stupid”.
I have a fundamental problem with just focusing on the arithmetic as it is too simplistic. Discount rates cannot be divorced from the economic context. Suppressed (and CB manipulated) bond yields (and therefore artificially low risk free rates) bastardise DCF analysis. A zero yield isn’t risk free because it’s signalling something. Suggests that economic risk is higher and therefore you should question the sustainability of the cash flow forecasts.
In other words, if you move from a world where risk free rates are replaced with interest free risk, you can’t linearly assume that the lower the yields the better that is for corporate valuations. Yes that’s true within normalised parameters. But once the risk paradigm has been twisted and broken, DCF analysis requires sophisticated judgment rather than just looking at the numerical outputs.
Because the interest rate is a hurdle against which the expected cash flows are measured. If the interest rate goes up the hurdle gets higher.
Then you have to account for the likelihood of the government to pay the interest on say the US10Y treasury against e.g. TSLA meeting the expected future cash flow to justify the price it has been rewarded.