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The BAN Report: Inverted Yield Curve / Strong Retail Data / FDIC Risk Report / WeWork IPO-8/15/19

Inverted Yield Curve

World markets plummeted this week as the yield curve inverted.

The yield on the benchmark 10-year Treasury note broke below the 2-year rate early Wednesday, an odd bond market phenomenon that has been a reliable, albeit early, indicator for economic recessions.

The yield on U.S. 30-year bond also turned heads on Wall Street during Wednesday’s session as it fell to an all-time low, dropping past its prior record notched in summer 2016. The two historic moves coming in tandem show that investors are increasingly worried, and indeed preparing for, a slowdown in both the U.S. and global economies.

Earlier Wednesday, the yield on the benchmark 10-year Treasury note was at 1.623%, below the 2-year yield at 1.634%. In practice, that means that investors are better compensated for loaning the U.S. over two years than they are for loaning for 10 years. The yields steepened later in the session, pushing the 10-year rate back above that of the 2-year note at 1.58%.

Data from Credit Suisse going back to 1978 shows:

  • The last five 2-10 inversions have eventually led to recessions.

  • A recession occurs, on average, 22 months following a 2-10 inversion.

  • The S&P 500 is up, on average, 12% one year after a 2-10 inversion.

  • It’s not until about 18 months after an inversion when the stock market usually turns and posts negative returns.

Going farther back in history, the yield curve’s track record gets a little more spotty. Post WWII, inversions have predicted seven of the last nine recessions, according to Sung Won Sohn, professor of economics at Loyola Marymount University and president of SS Economics.

While much of the economic news is positive (low unemployment, strong GDP growth, etc.), an inverted yield curve is an alarming sign. The risks of a recession will lessen if there is a favorable resolution of the US / China trade dispute, but a recession seems likely if trade tensions continue to worsen.

Strong Retail Data

Retail data was encouraging this week as Walmart reported strong sales and raised forecasts for the year.

Walmart Inc. said sales rose in the second quarter and it raised its profit forecasts for the year, extending the retail giant’s multiyear streak of growth as it takes market share from struggling competitors and expands online.

Sales at U.S. stores and websites operating at least 12 months grew 2.8%, due to strong grocery sales, online and off, and slightly more shoppers visiting stores and websites. U.S. e-commerce sales rose 37%.

“We’re gaining market share. We’re on track to exceed our original earnings expectations for the year,” said Walmart CEO Doug McMillon Thursday in a release.

Walmart now expects U.S. comparable sales to rise at the upper end of a 2.5% to 3% range for the full year, an improvement from an earlier prediction of sales falling somewhere in that range.

Meanwhile, retail sales in July jumped.

Retail sales, a measure of purchases at stores, restaurants and online, climbed a seasonally adjusted 0.7% in July from a month earlier, well above economists’ expectations, the Commerce Department said Thursday. Excluding autos, retail sales were up a robust 1.0% in July.

The broader trend this year shows steady growth in retail sales. Consumer spending increased 1.8% in the May through July period compared with the previous three months.

Americans increased their outlays in July at electronics stores, clothing stores and restaurants. Online sales were particularly strong, a possible result of Inc. ’s Prime Day, a day of deals on the e-commerce site.

“U.S. consumers continue to do very well,” said Ben Ayers, senior economist at Nationwide. “As consumers continue to see income gains and positive job gains…that’s obviously good news for growth and should keep us on a positive track for a while.”

Consumer spending is more than 2/3 of the economy and the consumer is strong. Lower interest rates could also boost the housing market as well.

FDIC Risk Report

Earlier this month, the FDIC released its new annual risk review.    The FDIC identified six key risk areas to banks, including Agriculture, Commercial Real Estate, Energy, Housing, Leveraged Lending and Corporate Debt, and Nonbank Financial Institution Lending.

The agricultural economy is now in its sixth year of low commodity prices and farm incomes, and agricultural exports have reflected pressure from trade uncertainties and slowing global growth. A slowdown in the agricultural economy is an important risk to the FDIC because farm banks are a large source of financing for the agriculture industry and represent about one-fourth of banks in the United States.

Commercial real estate (CRE) market fundamentals remain favorable as the economic cycle matures. However, outstanding CRE loan balances are rising, and competition among lenders to maintain market share in the face of slowing loan growth is increasing.

U.S. oil production reached record highs in 2018, but the energy industry is susceptible to volatility that has produced past boom and bust cycles. Banks most exposed to this geographically concentrated industry are vulnerable to future downturns

The housing market began to slow in 2018 as concerns about affordability intensified. Banks with concentrations in this portfolio could be vulnerable to the slowdown, but credit quality has been resilient so far.

Nonfinancial corporate debt as a share of gross domestic product (GDP) has reached a record high level. The increase has been driven by growth in corporate bonds and leveraged loans, which have become increasingly risky as the share of low-rated bonds has grown and lender protections in leveraged loans have deteriorated.

By lending to nondepository financial institutions, banks are increasingly accruing direct and indirect exposures to these institutions and to the risks inherent in the activities and markets in which they engage.

The last one is particularly interesting, as much of the riskiest lending has been pushed to non-bank lenders, who are financed typically with warehouse facilities from banks. For example, when the regulators cracked down on leverage lending several years ago, the credit shifted from banks to non-banks. We are already seeing material weaknesses in non-bank lending portfolios that could have larger repercussions.

WeWork IPO

Financial analysts are foaming at the mouth in criticism of WeWork’s filing for an IPO this week.   Bloomberg was especially critical.

The financial disclosures make it clear that WeWork — which, it should be said, is a commerce office leasing company and not truly a tech company — shares the hallmarks of Uber Technologies Inc. and other high-profile young technology startups.

At this point in WeWork's life, it’s tough to assess whether the company is economically viable in the long term. Its growth is overwhelming, but it’s not clear that it got there in a sustainable way. This company is a leap of faith, as are many of the young tech-ish companies hitting the stock market. Many of them have done poorly as public market stocks. 

In short, everything about WeWork is utterly odd. It is a real estate company valued like a tech company. It is a young company with questionable economics that has committed to paying tens of billions of dollars in future years for office building leases.  This is a company whose intricate relationships with its chief executive requires 10 pages of disclosures. And this may be the first time I’ve seen an IPO filing with a section titled “Expected Resilience in a Downturn.” 

WeWork may be the most magical creature in the last decade of richly valued “unicorn” startups that are attempting to bust up established industries. Its ambition is ambitious even by unicorn standards. So are its growth, losses, potential conflicts of interest and financial gymnastics. Succeed or fail, at least WeWork is not boring. 

We’ve seen this formula before.   Differentiate a company that is very much like another company (in this case Regus) and convince Wall Street that you are a technology company and deserve a much higher valuation. Regus filed for bankruptcy over a decade ago, so one wonders how the WeWork model will survive a recession. In the first six months of the year, WeWork lost nearly $700 million on $1.54 billion in revenue – a negative 45% net margin.

The BAN Report: China Devalues / HSBC Tosses CEO / Drugstore Disruption / Open Plan Offices Stink / Can't Live Alone in NYC on 100K-8/8/19

China Devalues

The trade war between the US & China heated up this week when China devalued its currency, weakening the renminbi to the lowest level since 2008.

China’s currency weakened past the psychologically important point of 7 to the American dollar for the first time in more than a decade, a move that reflects the growing severity of the trade war with the United States and that could indicate Beijing’s growing desire to find ways to retaliate against President Trump.

The renminbi traded in mainland China on Monday morning at roughly 7.02 to the dollar, compared with about 6.88 late on Friday. A higher number represents a weaker currency. The last time China’s currency was weaker than 7 to the dollar was in 2008, as the financial crisis mounted.

After the US formally labeled China a currency manipulator, China indicated it may continue to weaken its currency.    Columnist Thomas Friedman warned that the trade dispute was heading in a dangerous direction.

If you think that the United States-China trade dispute is going to be easily resolved, you’re not paying attention. It’s so much deeper than you think — and so much more dangerous.

If President Trump and President Xi Jinping don’t find a way to defuse it soon, we’re going to get where we’re going — fracturing the globalization system that has brought the world more peace and prosperity over the last 70 years than at any other time in history. And what we’ll be birthing in its place is a digital Berlin Wall and a two-internet, two-technology world: one dominated by China and the other by the United States.

Perhaps, this trade dispute could lead the US into a recession. While economists are notoriously bad at predicting recessions, there are a few warning signs that could indicate that we are entering a recession.    The New York Times noted four common indicators:

  • A rapid increase in the unemployment rate

  • A troubling yield curve (especially a flat one)

  • The ISM Manufacturing Index falling below 45 for an extended period

  • A 15% decline in consumer sentiment

Of the four noted, only the yield curve suggests trouble ahead.   But expansions don’t last forever, and a trade dispute between the US and China could end the longest economic expansion in the US.   Nevertheless, the US must address some serious issues with China’s trade practices.


After only 18 months, HSBC fired its CEO John Flint. Like John Flannery at GE, Flint appeared to move too slowly to fix HSBC’s problems, and lost the patience of its new Chairman, Mark Tucker.

Like Flannery, Flint inherited a mess. His predecessor, Stuart Gulliver had done a good job cleaning up most of the “stinking mess, the legacy of ill-conceived acquisitions and shoddy practice.” Gulliver had cut costs and gotten the business back on a relatively sound footing.

But there was much more to do even then. Everyone knew that. And Flint “said he will lay out his plans in a few months.” At the time, he “had been expected to ride a wave of improving profits as global interest rates started to rise and the world economy looked rosy. But those expectations were dashed as central banks began lowering rates again and geopolitical tensions roiled markets.”

Tucker was new as outside, non-executive Chairman. He didn’t want to change too much too fast then, choosing to converge before evolving the organization. He gave Flint a chance. But recently, as Ronit Ghose, bank analyst at Citi, said, “Mr. Tucker and HSBC’s directors had ‘clearly lost confidence in [Mr Flint’s] ability to navigate the tougher outlook faced by HSBC given the geopolitical and macro uncertainties, structural headwinds for global banks, and digital disruption challenges.’”

HSBC is in no rush to find a successor, as they expect to take about six months. Firing a CEO after 18 months is very unusual in this banking environment, especially when the bank was performing reasonably well. However, if Board want change in a Company, appointing an outsider is usually the way to go. Both Wells Fargo and GE made the mistake of promoting an insider first before pulling the plug.

Drugstore Disruption

This week, Walgreens announced it was closing 200 stores, while CVS Health said it would cut store openings.    The challenges facing brick-and-mortar retail are finally straining drugstores, which previously appeared immune from online retail.

On Tuesday, Walgreens disclosed it will close 200 U.S. stores. On Wednesday, CVS Health said it will slow the pace at which it opens new locations.

For pharmacies, which also face pressures related to reimbursements for medication, getting customers to come in once a month for a prescription refill, or for an occasional gallon of milk or bottle of shampoo isn’t enough. Walgreens and CVS are both trying to give customers more reasons to visit their stores by offering more health services and better merchandise.

Meanwhile, competition from Amazon and other bricks-and-mortar retailers has slowed sales of drugstores’ other merchandise, like personal care products, household goods, and food and beverage items, analysts said.

Most people still buy those items in stores, but drugstores haven’t invested enough in the retail side of their businesses to keep up with what consumers want, said Neil Saunders, managing director of GlobalData Retail.

Prices for food and household items at drugstores tend to be well above what consumers would see at a grocery store or on Amazon. There are times consumers are willing to pay for convenience, but “they realize it’s more expensive, and they resent paying it,” Saunders said.

Walgreens is still absorbing the acquisition of half of Rite Aid’s stores, and the closures represent less than 3% of their locations.    But, the decades-plus growth in drugstore retail locations appears to be over.

Open Plan Offices Stink

Recent research suggests that open plan offices do not work and stifle collaboration.

But open plan offices are worse. Much worse. Why? Because they decrease rather than increase employee collaboration.

As my colleague Jessica Stillman pointed out last week, a new study from Harvard showed that when employees move from a traditional office to an open plan office, it doesn't cause them to interact more socially or more frequently.

Instead, the opposite happens. They start using email and messaging with much greater frequency than before. In other words, even if collaboration were a great idea (it's a questionable notion), open plan offices are the worst possible way to make it happen.

Previous studies of open plan offices have shown that they make people less productive, but most of those studies gave lip service to the notion that open plan offices would increase collaboration, thereby offsetting the damage.

The Harvard study, by contrast, undercuts the entire premise that justifies the fad. And that leaves companies with only one justification for moving to an open plan office: less floor space, and therefore a lower rent.

But even that justification is idiotic because the financial cost of the loss in productivity will be much greater than the money saved in rent. Here's an article where I do the math for you. Even in high-rent districts, the savings have a negative ROI.

More important, though--if employees are going to be using email and messaging to communicate with co-workers, they might as well be working from home, which costs the company nothing.

We are amazed that so many companies blindly bought into this ridiculous concept in the first place. Perhaps, they should listen to their employees and not consultants peddling their latest idea. The research shows clearly that open plans lead to less interaction, and more email and headphone use. Perhaps, we can blame WeWork’s popularity for popularizing this fad. WeWork still promotes that open plans increase communication.

When an office lacks physical barriers, employees are more likely to communicate with one another and work as a team. Naturally, improved communication boosts collaboration efforts between various levels of employees, so even a manager can feel more approachable.

There’s a word for this and it isn’t suitable for a family publication!

Can’t Live Alone in NYC on 100K

It’s becoming increasingly impossible to live alone in most areas of New York City unless you are earning at least six figures, according to StreetEasy.

Solo renters in some popular Brooklyn neighborhoods -- Prospect Heights, Brooklyn Heights, Fort Greene and Cobble Hill -- now require a yearly salary of at least $100,000, but didn’t five years ago, according to a study by StreetEasy. Manhattan’s Lower East Side also entered the six-figure club.

StreetEasy looked at neighborhoods with at least 250 rentals available in 2019 and determined the salaries needed to afford a median one-bedroom or studio apartment, assuming no more than 40% of income is spent on rent. Manhattanites living alone would need a gross income of $115,800 -- more than twice the city median of $57,782, StreetEasy said.

This is precisely why housing advocates in New York successfully pushed for tenant-friendly legislation, although the real estate industry is fighting back in federal court, claiming that Albany’s new laws represented an illegal taking of property.

The Community Housing Improvement Program, a trade group that represents 4,000 building owners, joined other landlord plaintiffs in the lawsuit arguing that rent stabilization laws "effect a physical taking of property in violation of the Constitution's Takings Clause," according to the suit, citing a clause of the Fifth Amendment.

The suit, filed in U.S. District Court in Brooklyn this week, is not asking for monetary damages, but instead seeks to have New York's new rent stabilization laws thrown out.

Other cities are facing the same challenges with higher rents putting pressure on its residents. While less restrictive zoning offers a solution to the supply problem, there is little appetite in these high-rent cities for increased density.

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