<h2>Market update: Off to the races</h2>With a gain of more than 2%, the S&amp;P 500 is headed into the weekend firmly above 4,000 for the first time since mid-December. The breadth of the rally was wide, with nearly 400 stocks in the green on the week. The tech-laden NADSAQ 100 outperformed, with its +4% rise pushing it above its 200-moving average for the first time since March 2022.&nbsp;That said, stocks don’t have an all clear signal yet. Only one quarter of the S&amp;P 500 has reported Q4 2022 earnings. The takeaway so far: A mixed bag, but better than feared. For one, J&amp;J beat earnings, despite a slowdown in revenue and sales in the face of a strong dollar and diminishing COVID-19 vaccine demand. Microsoft’s Azure cloud business persists as its engine of growth, but the company seems poised to guide expectations lower from here. Looking ahead, many of the “big name” announcements are still to come, including the likes of Google, Apple and Amazon next week.&nbsp;In the bond market, Treasury yields did a round-trip as economic data showed bits of both strength and weakness. On one hand, preliminary U.S. Manufacturing and Services PMIs for January continued to point towards contraction. On the other, filings for unemployment benefits hit their lowest level since early last year. This leaves investors wondering when, and if, the next shoe will drop.&nbsp;Elsewhere, the U.S. government is still grappling over what to do with the debt ceiling, and other big macro catalysts, such as the February FOMC meeting and January nonfarm payrolls, are on deck for next week.&nbsp;In the meantime, here are five quick observations worth paying attention to.&nbsp;1. The U.S. economy: Strong (at first glance), but losing steam. The latest GDP data showed that the U.S. economy grew at a +2.9% real (inflation-adjusted) pace through the final quarter of 2022. The headline number implies strength, but digging into the details reveals less favorable dynamics. There were three components that caught our attention: 1) Inventories, which continued to build as goods demand weakened, contributing about half of the growth reported, 2) consumption, which came in still-solid, but slower than expected, and 3) capex (offering a pulse check on corporate America), which appears to be cooling despite firm spending on tech. In all, the report suggests that while the U.S. economy grew at the end of last year, it appears to be losing momentum.&nbsp;<img src="/uploads/Slide1_17190daa11.jpg" alt="Slide1.jpg">2. The bond market: A record start. Bloomberg’s global bond index has surged over +3% in 2023, the best start to a year in over two decades. The prospect of the end of the global tightening cycle is prompting borrowers to seek opportunities to raise financing and making investors finally ready to take on debt. Global issuance of investment- and speculative-grade government and corporate bonds across currencies reached near $600 billion year-to-date (through Jan. 18), the biggest tally on record for the period.&nbsp;Take Caesars Entertainment (stock +27% year-to-date), which offered over $3 billion in bonds and leveraged loans earlier this week, one of the biggest refinancing deals in both markets this year. Investors jumping on “risky” debt issuance gives companies like Caesars a little longer runway, but it’s unclear what the Fed thinks about the recent easing of financial conditions. We still prefer to stay in the high quality parts of the market, given we expect spreads for riskier bonds to widen meaningfully from here in the event of a recession.&nbsp;3. European equities: First inflows in nearly a year. While the sum of inflows was only $200 million last week, it’s a significant turnaround from near-record outflows just one year ago. The catalyst: The worst case economic scenario for the region seems to have faded over the past few months. A warmer-than-feared winter has left natural gas supplies near ~75% of storage capacity, relative to the ~55% typically seen at this time of the season. The strength in activity data (most recently, January Eurozone composite PMIs unexpectedly entered expansionary territory for the first time since last summer) combined with easing inflationary pressures from dramatically lower energy prices has led to a +20% equity rally (in local currency terms) from late last year’s lows. For U.S. dollar investors reaping the tailwind of a weaker USD, it's an even higher 30%. Looking ahead, investors may look at the still-wide valuation discounts (~25% relative to the U.S.), brighter economic growth prospects, and a peaking dollar as reasons to keep adding to ex-U.S. exposure.&nbsp;<img src="/uploads/Slide2_35df1c7233.jpg" alt="Slide2.jpg">&nbsp;4. Corporate layoffs: The list is growing, yet the stocks are among the best performers this year. The latest tally of layoffs (which now include many of the mega cap tech names) reveal that the companies are persistently contained within tech, finance and real estate – the most interest-rate sensitive sectors of the economy. Notably, so far this year, these sectors in the S&amp;P 500 are also at the top of the returns leader board. Communication services (+13.4%), tech (+9.4%), and real estate (+8.2%) are outperforming the broader index (+5.6%) with financials (+5.8%) nearly in-line. Broad weakness across industries has yet to reveal itself (as we expect in our base case scenario by year-end), yet these dynamics keep the sought-after soft landing window open.&nbsp;<img src="/uploads/Slide3_fc4edcab53.jpg" alt="Slide3.jpg">5. Housing: Finding a footing. Following a record string of declines over the past two years, sales of new homes in the U.S. rose for a third consecutive month in December. Housing starts for single-family homes also saw their first gain in four months. The 1% fall in mortgage rates catalyzed the largest weekly jump in mortgage applications since 2020. While it’s hard to tell a story or predict a path forward from early-days data points, signs are pointing towards a sense of stability in what has been the most beaten up segment of the economy over the past year.&nbsp;The equity market is also paying attention to the green shoots. S&amp;P Homebuilders, which includes businesses from appliance stores to, the obvious, home building materials sellers, bottomed in June of last year and is now up near +30% from lows (with over a third of the rally coming just over the past few weeks). While housing market conditions are merely inflecting, the equity market is starting to feel comfortable with the direction of travel.&nbsp;The remaining question lies in how the Fed is feeling about, by one metric, the loosest financial conditions we’ve seen since early last year. The shift in sentiment is re-activating capital markets, but early optimism may be a concern in the midst of still-elevated inflation. At the February FOMC meeting, we expect Chair Powell to hike the policy rate by 25bps and remain on the front foot with hawkish rhetoric.&nbsp;Although the end of the tightening cycle is likely near, we also believe that we’re not yet out of the woods. Investors have historically been rewarded for sticking with their long-term plan, and considering opportunities that fit within their risk profile – amongst the opportunities we think are worth considering today are core fixed income, preferreds, small- and mid-cap equities, and more specific dislocated segments such as semiconductors.&nbsp;As always, your J.P. Morgan team is here to discuss these insights with respect to your portfolio.&nbsp;<h2>Disclosures</h2>All market and economic data as of January 27, 2023 and sourced from Bloomberg and FactSet unless otherwise stated.&nbsp;The Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.&nbsp;The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases.&nbsp;The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.&nbsp;Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.&nbsp;The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to 'stock market risk' meaning that stock prices in general may decline over short or extended periods of time&nbsp;We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.&nbsp;<h2>Risk Considerations</h2>Past performance is not indicative of future results. You may not invest directly in an index.&nbsp;The prices and rates of return are indicative, as they may vary over time based on market conditions.&nbsp;Additional risk considerations exist for all strategies.&nbsp;The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.&nbsp;Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.&nbsp;<h2>Important Information</h2>All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.&nbsp;Bonds are subject to interest rate risk, credit and default risk of the issuer. Bond prices generally fall when interest rates rise.​ Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss. ​

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Bond market boom. Housing finding a footing. Europe’s surprise strength. Here are a few compelling market moments for the week.

5 facts for investors to consider

Innovation in battery technology has been a key driver of the electric vehicle (EV) revolution. A mere decade’s worth of progress has taken EVs from a range of a 100 miles to an average of 250 miles on a single battery charge.&nbsp;The momentum behind the industry is palpable. Those looking to buy EVs now have every major automaker vying for their custom compared to a handful of hopefuls making their business pitches a decade ago. Geographically, China leads the way with an estimated 30% market penetration rate for 2022. Europe and the US follow with 15% and 10% penetration rates respectively.&nbsp;The twin demands for increased energy density enabling longer journeys, and lower battery cell costs leading to an improvement in consumer affordability, continue to fuel the latest innovations. But the link of battery power with progress makes continual advancements on this front crucial for making EVs go mainstream.&nbsp;Grasping what’s needed demands a short lesson in the rudiments of battery chemistry. A battery comprises three things – a cathode (or positive electrode), an anode (or negative electrode), and electrolyte – the liquid that maintains the flow of ions between the cathode and anode connecting the two (and completing the power generation and charging circuit).&nbsp;Innovators and investors have been focusing broadly on improvements in cell design and cathode materials using Lithium-ion batteries. And cathode chemistry will remain important near-term, especially as raw material prices experience unprecedented volatility.&nbsp;However, the report suggests the next frontier for batteries will likely be in the advanced anodes of a battery via the development of high-performance synthetic materials versus the graphite materials currently in use. Progress here could positively impact a battery’s charging speed, capacity and ultimately its life cycle.&nbsp;A related move involves the development of “solid-state battery systems.” In layman’s terms, that’s simply replacing the liquid electrolyte in a battery with a solid. According to battery chemistry theories, such a system has zero to negligible wasted battery space compared to its liquid counterpart, and can hypothetically provide infinite energy density.&nbsp;Should a meaningful shift - from graphite materials (currently in use) to high-performance synthetic graphite to high-content silicon to eventually lithium metal - take batteries closer to a solid-state system, EVs may have “energy densities of 500 Wh/kg, likely enabling vehicle ranges over 500 miles,” the report adds.&nbsp;EVs could then compete better with the internal combustion engine (ICE) vehicles of today many of which are capable of running 450 miles on a tank full of petrol. However, at present, such a battery appears expensive to replicate beyond the laboratory. There is also a lack of progress on solid-state battery short-circuits caused by dendrites, or small cracks in the solid electrolyte that form over time.&nbsp;Such obstacles on the road to commercialization for these technologies are challenging. “But companies that can scale-up with existing manufacturing techniques and achieve cost parity would be the winners,” the report notes. They would potentially require patient investment. Investments are an Unstoppable Trend Greening the World.&nbsp;Of course, envisioning progress in electric mobility also raises another important question – can anything disrupt Lithium as the industry’s preferred chemical element for long-range batteries? The answer is a complex one since many next generation batteries, e.g., solid-state systems, will likely use even more lithium in the future.&nbsp;Combination batteries blending Lithium Ferro Phosphate (LFP) and Na-ion batteries may improve fast charging and provide low temperature performance, according to the report. However, this may come at the cost of reduction in system energy density even further – a compromise that may be hard for auto manufacturers to stomach.&nbsp;Other transformative technologies – for e.g., Lithium-air, Lithium-sulfur, multi-valent batteries – will likely take several decades of innovation. Therefore, a medium-term dethroning of Lithium as a preferred battery element appears unlikely.&nbsp;However, future battery safety enhancements could bring long-term changes. For context, due to the use of flammable liquid electrolyte, Lithium-ion batteries are prone to thermal runaway. It leads to batteries failing catastrophically and creating fires that are difficult to extinguish. Such events, though rare, threaten passenger safety.&nbsp;To date, battery makers have focused on safety enhancements based on separator technology, impact resistant and fire suppressing battery housings with considerable success. But focus is gradually turning to the flammable liquid electrolyte. Some have begun working with proprietary non-flammable or self-extinguishing electrolytes and interfaces that suppress dendrite formation, one of the leading causes of a battery short circuit.&nbsp;Overall, better safety, affordability, range and fast charging will continue to be the focus of innovators and investors looking to encourage long-term EV adoption. But both sets of enthusiasts should note that much of the progress on these four fronts will come down to the battery powering it.

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Better safety, affordability, range and charging times will remain the focus of innovators hoping to make electric vehicles go mainstream.

Evolving battery technology will drive the next electric vehicle

Better safety, affordability, range and charging times will remain the focus of innovators hoping to make electric vehicles go mainstream. Could advanced anode technology be the answer?

Evolving battery technology will drive the next wave of electric vehicle adoption

The starting position at the beginning of 2023 is much more favourable than back in January 2022. Why has our Group Chief Investment Officer outlined changing inflation, the actions of the US Federal Reserve, and more as some of the key points for investors to watch out for? Explore this month’s #CIOViews below for insights.&nbsp;The cost of capital has returned to normal over the past year and after last year’s setback, expected returns have significantly moved upwards across the entire risk and currency spectrum. Overall, the balance between risks and opportunities is much better at the beginning of this year than at the same time last year. There is yield in portfolios again – a situation we have not seen in almost 10 years.&nbsp;<h2>The US economy continues to prove its resilience</h2>One of the most striking features of 2022 was the seeming indifference of the US economy to changes in policy rates. Its ability to withstand 425 basis points of rate hikes in only nine months without something breaking along the way is nothing short of remarkable. In hindsight, this is mainly due to the strong financial position of the US private sector.&nbsp;<img src="/uploads/antonio_costa_d4f47c3d63.jpg" alt="antonio-costa.jpg">US households can still draw down pandemic-induced excess savings, while debt service burdens are historically low thanks to a decade of low interest rates. As a result, consumer spending in the US is back to pre-pandemic levels, even when adjusted for inflation. The listed US corporate sector, for its part, can still rely on nearly 90% of its debt being financed at fixed rates with an average maturity of seven years. Clearly, it will take some time for higher interest rates to work their way through to corporate financing costs.&nbsp;<h2>Inflation is much better than it looks</h2>On the inflation front, it is worth mentioning that year-on-year rates obscure the progress made below the surface in recent months. In fact, US inflation fell dramatically in the second half of 2022. The latest US headline inflation print for December marked the sixth straight monthly deceleration. Irrespective of the headline inflation measure chosen, the annualised growth rate has broadly decelerated to below 2% over both the last three and six months.&nbsp;<img src="/uploads/csm_us_headline_inflation_01_3c7d9ab89a_ce393502da.jpg" alt="csm_us-headline-inflation-01_3c7d9ab89a.jpg">Admittedly, lower food and energy prices were the biggest contributors to the decline, and it remains to be seen whether the recent volatility in these inflation components has permanently subsided. However, the improvement comes at a time when the Fed’s tightening measures have hardly yet been transmitted to the real economy. Instead, the supply-chain bottlenecks have now largely dissipated, leading us to conclude that the ‘transitory inflation’ camp of early 2022 may not have been entirely off the mark after all.&nbsp;<h2>The Fed does not want risk assets to recover for the time being</h2>Nonetheless, the Fed is currently facing both a problem and a constraint. The problem is that the American monetary institution had been fighting the challenge to avoid deflation for two decades, and now it is afraid of being discredited. It is willing to accept anything, even a recession, to put inflation back in its box. On the other hand, in this epic battle against post-pandemic inflation, the Fed is also constrained by the US electoral agenda, as 2024 is a presidential election year.&nbsp;<blockquote>The Fed will not want any premature easing of financial conditions, and any attempt by the S&amp;P 500 to rally will be met with renewed hawkish rhetoric from Fed officials.</blockquote>&nbsp;The economy simply cannot fall into a recession at a time in which the campaign for the White House is in full swing. Thus, the Fed must keep a lid on prices now. It will not want to risk inflationary pressures lingering at the end of 2023 and be forced to choose between inflation and recession during the election process. Therefore, the Fed will not want any premature easing of financial conditions, and any attempt by the S&amp;P 500 to rally will be met with renewed hawkish rhetoric from Fed officials. This situation is likely to continue until the Fed is satisfied with the decline in inflation, allowing it to consider the retreat that began a few months ago as virtually irreversible.&nbsp;<h2>Quantitative tightening is the main risk going forward</h2>Corporate management enters the new year with a cautious attitude and subdued capital expenditure intentions, which should help protect margins. As the main concern on markets is shifting from inflation to growth, investors are likely to focus increasingly on the earnings resilience of corporates going forward, including costs. As for the Q4 2022 earnings season, which has just started, analyst consensus expectations have recently been revised downwards, limiting the room for negative surprises.&nbsp;We believe that the Fed’s effort to reduce its balance sheet (i.e. decrease the amount of liquidity in the economy via quantitative tightening) represents the main policy-mistake risk. This could, at some point, lead to market liquidity suddenly drying up, which lies at the basis of financial turmoil. Private-sector credit growth has helped to absorb the liquidity drainage for now, but it remains to be seen whether private credit demand stays elevated in the context of the normalisation of the US economy after the present reopening boom fades.&nbsp;Meanwhile, the worst already seems to be behind us, with the latest data showing that global liquidity growth has bottomed out. Should nominal growth decelerate sustainably, as suggested by the latest inflation figures, liquidity could shift again from the real economy to the financial one, leading to further stabilisation in asset prices.

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The starting position at the beginning of 2023 is much more favourable than back in January 2022. 

What investors need to know in 2023

<h2>Key Takeaways</h2>As rates rise, the underwriting and documentation of credit investments becomes more important, particularly for leveraged loans and private credit due to the floating-rate nature of the products.Heightened syndication risk has led more borrowers to pursue private credit, which carries more stringent terms and documentation but also more certainty of execution because capital is generally drawn from dedicated funds.Amidst ongoing market volatility, investors need to be cognizant of how credit exposure in their portfolio is structured, and how hedges are being implemented to reduce FX and rate risk. Lenders and borrowers collaborated well during the pandemic, but few private lenders have been tested through an extended downturn.&nbsp;Debt financing in recent decades has grown cheaper and easier to procure, with fewer strings attached as lenders competed for financings. Now, the market is beginning to turn. Rates are rising, underwriting is tightening, and terms are shifting. Credit assets are often assessed at a headline level, only considering basic characteristics like the coupon, rating, and duration, but the underlying terms and structures are key to understanding how these assets might behave in a downturn. It’s important for credit investors to not only understand the terms of deals being done today, but also the terms of their existing portfolio and which ones may become more important when rates rise and growth slows.&nbsp;Over the last decade, terms for leveraged loans have increasingly resembled high yield, but the borrowers tend to have lower ratings and the debt is floating rate, which has implications in today’s market. The vast majority of leveraged loans today are classified as covenant-lite—but that doesn’t mean borrowers are without protections or recourse. Private credit, for its part, is growing and in many ways filling a gap left as the leveraged loan market evolves; larger private credit fund sizes and new loan structures are enabling lending that was not feasible in the past. An added wrinkle is that the more structured credit investments utilized in private markets have a variety of embedded terms and features that complicate analysis, providing the potential for additional upside and—more importantly in the current environment—downside risk reduction.&nbsp;<h2>Credit Term Terminology</h2>Origination and StructuringWhen new loans are formed, originators set the initial terms and include standard features like voting rights and mandatory prepayment conditions. Lenders tend to require that proceeds from loans serve an express purpose, often related to a specific acquisition or capital expenditure. Separately, mandatory prepayment helps to ensure lenders are repaid in the event of asset sales and corporate events. Terms are necessarily more standardized for syndicated deals involving multiple lenders.&nbsp;The bilateral nature of private lending allows for close alignment between borrowers and lenders. The documentation for private loans often stipulates that the borrower must provide monthly financial statements, whereas public market lenders are beholden to quarterly reporting cycles, which can be further delayed by audits. This allows both sides in private credit relationships to be proactive before potential issues arise. While the terms are more stringent, private lenders often work closely with borrowers to establish bespoke conditions and arrangements that not only provide an ex-ante playbook for distressed situations but can also help to course-correct before more severe action is needed.&nbsp;The most fundamental protection for corporate lenders is collateral, which can include inventory, receivables, hard assets, and capital stock of operating units. While the concept of collateral is straightforward, there should be clear documentation about how collateral is protected (e.g., a negative pledge that prohibits assets as being pledged as collateral to different lenders).&nbsp;Inadequate documentation and ambiguous language have led to disputes over collateral between borrowers and lenders in the leveraged loan and private credit spaces. These issues often surface when a borrower attempts to move assets outside of the legal entity with the obligation to the lender. In recent years, several private equity-backed companies have attempted—with varying degrees of success—to move business units, real estate, and other assets including intellectual property. The most infamous examples involved companies transferring intellectual property to an unrestricted subsidiary, in what is now often referred to as a “trap door.”&nbsp;Prudent lenders have always addressed these issues, but market terms have broadly adjusted to address the risk of the “trap door” and similar efforts to shift collateral to enable further borrowing. Today, borrowers generally have few allowances for removing assets from the entity being lent against, but investors need to be aware of risk and ensure proper protections are in place. As with other terms, private creditors are generally better able to document collateral at the onset and track it over the course of the loan given the bilateral relationship and tighter reporting standards.&nbsp;SyndicationThe heightened pricing uncertainty of syndication in today’s market is one reason why private lenders have grown more popular. For deal financing, which is a primary purpose of leveraged loans and private lending, there is typically a gap of several months between when the deal agreement is in place and the transaction actually closes. In public issuances, flex provisions allow lenders to change the spread or size of the tranches during syndication to reflect market pricing. This has become increasingly important in the current market environment, as rising rates have made it more difficult to syndicate loans that were underwritten in more favorable borrowing environments. The average bid for new issues is around 95 cents on the dollar, pushing the yield for newly issued B-rated paper to more than 11%.&nbsp;The freezing of the banking and syndicated loan markets through 2022 has made the certainty offered by private creditors increasingly attractive. Rather than syndicating loans, these lenders generally draw capital commitments from closed-end funds, assuming the risk of holding the paper. This structure also tends to lead to fewer lenders in each transaction, helping to streamline the process. Even before the current market disruptions, borrowers had been increasingly opting for the flexibility of private lending, with the shift towards private credit underway for some time. While difficult to quantify in its entirety, the private credit market can be examined through several proxies including business development companies, where the share of private lending versus syndicated loans has shifted from 50/50 in 2016 to about 75/25 in recent years.&nbsp;CovenantsFor loans that are already in place, covenants help to ensure the borrower maintains a sufficient operational trajectory to service the debt. Affirmative covenants are common and fairly standardized, requiring the borrower to take basic actions associated with the loan (e.g., pay interest). Even loans categorized as “cov-lite” will carry these terms. Negative covenants are more bespoke and tailored to the specific company’s situation, detailing restrictions on corporate activity (e.g., mergers &amp; acquisitions, dividends, asset sales). Most covenants center on financial metrics, including balance sheet strength, cash flow coverage, and capital expenditure levels.&nbsp;Negative covenants take two basic forms: maintenance and incurrence. As the name suggests, maintenance covenants require that a borrower “maintain” the ability to pass certain tests of financial performance on a periodic basis. While lenders technically have the right to accelerate a loan when a maintenance covenant is breached, the more common option (and typically more fruitful route for both parties) is to negotiate additional fees, a wider spread, more collateral, or similar concessions. Some loan agreements include provisions for “equity cures,” which allow the borrower to address a covenant breach by making an equity contribution. Incurrence covenants tend to cover similar aspects as maintenance covenants but only are tested if the borrower takes specified corporate actions, such as paying a dividend, issuing debt, or executing a transaction.&nbsp;<h2>Cov-Lite Doesn’t Mean Cov-Less</h2>Over the last decade, the term “cov-lite” has become virtually synonymous with leveraged loans, commanding more than 90% of the market. The common assumption is that this shift reflects a widespread disregard for incorporating basic protections into underwriting. The reality, however, is that cov-lite simply means that the loan has incurrence covenants—historically associated with investment-grade paper—rather than the maintenance covenants that the leveraged loan market initially coalesced around. To that end, the near ubiquity of cov-lite loans is more a reflection of the institutionalization of the market than a complete disregard for underwriting standards. In fact, LCD—the preeminent provider of leveraged loans data—ceased reporting on many aggregate maintenance covenant statistics due to the market’s widespread adoption of incurrence covenants (i.e., cov-lite).&nbsp;Even with the prevalence of cov-lite loans today, covenant relief in the leverage loan market was needed en masse during the pandemic. Almost all this relief pertained to pro rata loans, which includes revolvers and amortizing debt that are required to have covenants, as opposed to tranches sold to institutional investors. During the initial months of the pandemic, leveraged lenders worked with borrowers to allow them to draw on revolvers despite many failing to meet their incurrence covenants due to operational disruptions caused by lockdowns.&nbsp;In private credit, senior direct lending and unitranche deals at the top end of the market have gravitated in a similar cov-lite direction as leveraged loans. Most private loans to middle-market borrowers, however, still carry maintenance covenants, typically including one that is financial in nature. Many borrowers were at risk of triggering those financial maintenance covenants, leading lenders to provide liquidity relief via changes in amortization schedules, switching to payment-in-kind (PIK) rather than cash interest, and even direct capital infusions. These deals often carried liquidity covenants, while offering leeway on leverage and fixed-charge covenants that might otherwise have been tripped.5 While these measures proved effective, how the market will respond during a prolonged economic downturn has yet to be seen since private credit was relatively nascent during the global financial crisis. In many cases, private lenders tend to view themselves as partners of equity owners and would prefer to find amicable resolutions in distress situations rather than pursuing workouts.&nbsp;Despite the Prevalence of Cov-Lite Loans, Many Borrowers Sought Covenant Relief During the Pandemic<img src="/uploads/perspectives_credit_terms_chart_d_2df7cb8cca.avif" alt="perspectives-credit-terms-chart-d.avif">Source: Leveraged Commentary &amp; Data (LCD). As of October 31, 2022.&nbsp;Another common remedy for borrowers in recent years, whether for reasons of stress or convenience, was to amend-and-extend their existing loans. Under these transactions, the maturity on existing liabilities is extended further into the future with the option for lenders to convert to longer-dated paper with a wider spread. The amendment portion of the transaction, which requires a majority vote of the borrower group, stipulates the amount of the extension and the new spread as well as any revised terms. Amend-and-extend activity for leveraged loans hit record levels in recent years amidst attractive financing conditions, pushing out the maturity wall for leverage loans; at year-end 2020, more than $350 billion of leveraged loans were set to mature in 2023 and 2024, compared to about $120 billion today.&nbsp;More Downside Risk ReductionHedging has not been a central topic recently due to the relatively benign rate environment, but risk reduction has come to the forefront given the inflationary backdrop and aggressive policy response. Due to the floating-rate nature of leverage loans and private market debt, many lenders require borrowers to have a certain amount of interest rate hedging in place. While some borrowers are already hedging their rates exposures, lenders may increasingly ask borrowers to implement interest rate hedges to ensure debt servicing is maintained. This often takes the form of interest rate caps, which act as an insurance policy against rising reference rates like SOFR. The need for hedging has increased in recent years as more financial sponsors are opting to exclusively use floating-rate structures to finance deals. While some borrowers will have termed out that exposure when markets were favorable, an analysis of the high-yield market suggests that many borrowers still have significant floating-rate liabilities.7 Prepayment is also typically easier for floating-rate instruments, presenting a risk to lenders, but in today’s market many have been able to better negotiate call protections. Foreign exchange (FX) hedging, while not as frequently featured in loan agreements, is becoming an increasingly salient topic for both borrowers and lenders too. For many private market strategies, currency hedging is relatively less important due to the long investment horizons and focus on capital appreciation; but yield-oriented strategies, such as private credit, are more exposed to fluctuations in FX markets due to the more consistent cash flow.&nbsp;Considering the Upside PotentialCredit investors are inherently focused on downside risk reduction, particularly in tumultuous and volatile markets, with little additional upside potential beyond recouping the par value of the bond. In today’s tight lending market, borrowers may need to include additional upside opportunity through warrants or other incentives to entice lenders. Certain strategies, such as mezzanine, have always included warrants and equity features as standard operating practice, but the terms for more general direct lending strategies shift over time with market conditions. To that end, so-called “structured equity” investments, which include components of both debt and equity, have gained traction recently as a viable middle ground for companies in need of capital but unwilling to take on pure debt and reluctant to raise equity at depressed valuations.&nbsp;<h2>Adapting to Market Realities</h2>Many credit investors have yet to experience a full market cycle, and for those who have, markets look fundamentally different today than they have in the past. The leveraged loan market has risen in prominence and shifted to look more like high yield. Private credit has also gained traction, with an increasing spectrum of sub-strategies and underwriting features and provisions. As evolution in the space continues, investors need to understand the underlying positions of their credit portfolio. Particularly in private markets, where the terms can vary greatly from deal to deal, broad strategy labels may not accurately reflect the holdings within. As covered in a prior Perspectives article, the interest coverage ratio is a simple metric that can be used to judge a company’s ability to repay debt. Aggregate stats suggest general health in the market, but coverage ratios are significantly different across sectors and between companies—underscoring the need to understand idiosyncratic holdings.&nbsp;For new debt issuances, lenders have already seen their negotiating positions improve in credit agreement structuring. Lower-quality companies are seeing the most significant tightening, but terms are also shifting for high-quality borrowers. Going forward, the shift to cov-lite debt—with incurrence rather than maintenances covenants—is unlikely to reverse in the leveraged loan market. Instead, we expect to see increased nuance in the structuring of incurrence covenants and more stringent restrictions on how borrowed cash can be used. Private creditors are likely to be able to command the most stringent terms, as the borrower base tends to be riskier; however, higher-quality companies are increasingly showing a willingness to engage with private credit and forge a closer relationship with a lender.

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Debt financing in recent decades has grown cheaper and easier to procure, with fewer strings attached as lenders competed for financings.

Credit Terms: The Rising Importance of the Fine Print

Among the components of the World Economic Forum’s Great Reset are a drastically reduced population and the replacement of human labor with robots and artificial intelligence (AI). The question immediately comes to mind: can robots and AI really make all the stuff for the elites after they have gotten rid of the people?&nbsp;Podcaster and journalist James Delingpole, speaking to investigative journalist Whitney Webb on October 23, 2021, discussed this topic with his guest. I have transcribed several minutes from their conversation, edited for concision:&nbsp;Webb: The fourth industrial revolution. One of the main pillars of that is automation and artificial intelligence. We’ve already seen that with corporate behemoths, like Amazon’s efforts to replace human workers with robots. Starbucks is piloting their AI barista with plans to have at least one in most if not all locations…. How long until humans are gone entirely? That’s in a retail setting.&nbsp;In the UK Tesco recently joined the cashier less checkout. It’s all done on your phone. You scan when you enter the store. Everything is tied to you, your unique digital identifier with the corporation. You can just walk out of the store. How convenient that you didn’t have to walk by a cashier at all.&nbsp;We’re going to see this happen in big ways in manufacturing. Chile is one of the biggest producers of copper in the world. In the northern part of Chile, the economy is driven by mining…. They are automating the mining here [in Chile]. Most of Chile’s middle class in the north work in the mining industry. They are about to all be cut out….&nbsp;It’s infinitely more profitable for a corporation to make an initial investment in a robot or an AI algorithm than to continuously pay a worker. Not have to deal with sick pay. There are efforts all over the world to demand better worker benefits. Better hours. Robots are the ultimate worker for a lot of these people because they are not interested in the human equation of things. There is a move to a human-free future coupled with anti-human rhetoric.&nbsp;The substitution of machines for human labor is a process that has been going on since the first industrial revolution. A considerable amount of manufacturing is already done by robots. But does it matter if a machine is a robot or not? Telecommunications switches connect calls that used to be done by telephone operators. We do not identify these machines as robots (perhaps because they do not have a recognizable torso and limbs or perhaps because they perform their work on data rather than physical objects) but the impact on the demand for labor to perform those tasks is the same.&nbsp;Contrary to Webb, it is not “infinitely more profitable” for a corporation to use an AI-powered robot in place of a person. Profitability is a calculation that depends on the price of the robot, the productivity of the robot, the wages of the person and the productivity of the human worker.&nbsp;The substitution of capital for labor makes economic sense when the cost of the capital goods per unit value of output—including paying for the entire supply chain—is less than the wages of the person that is replaced.&nbsp;Yes, workers are paid wages. However, robots and other machines are themselves not free goods. They must be designed, tested, and maintained. They are made of many parts which must be manufactured and transported. The manufacturing process is performed by some combination of people and other machines. The parts are ultimately made from materials that are mostly mined or extracted from the earth, also by men and machines.&nbsp;Workers prefer better working conditions over worse. And for machines as well there are optimal working conditions. A truck that is driven on poor roads in bad weather will wear out or break down more quickly. Computers need a carefully tuned environment that is temperature and humidity controlled. Computer servers are housed in a complex capital good known as a “data center.”&nbsp;The wages that are required to hire the workers are determined on the labor market, by the various competing uses for each person’s skills. If the cost of the robot is less than the worker, that is only because their labor is more urgently demanded doing something else. There is a greater need for human labor somewhere else in the world.&nbsp;AI itself is not inexpensive. Building and running AI requires engineering effort and computing resources such as networks, servers, and storage. AI models are trained by data that must originate with the same human intelligence that the AI is trying to reproduce. If you want to train AI to recognize photographs of cats, someone must have taken the photographs and classified them as cats or “not cats” so that the AI can be validated. If the photos come from security cameras, someone must have installed the cameras.&nbsp;After the model is built it must be maintained. AI models do not run perfectly forever. They must be monitored for drift, and it requires a human to determine if the drift is due to an error in the ingestion of data, such as a change in units, or a true change in the customer preferences that the model is trying to extract. In the latter case, the model must be retrained on a new data set.&nbsp;Modern computer systems are built with some degree of self-diagnosing and self-repairing abilities. But the automation must punt all but the most straightforward cases into a call for help that brings a human into the process. Humans are necessary to diagnose problems and restore service when something has gone wrong.&nbsp;The manufacture of machines such as robots requires a complex structure of production with perhaps tens of thousands of individual parts. Each part must be designed—by a person—manufactured and integrated with the other parts. The integrations, including isolating manufacturing defects, must be tested, and debugged.&nbsp;Parts are transported by industries such as shipping and trucking. All of these steps involve combinations of labor and capital goods. It is true that people take sick days, however, machines break, wear out, and, and require repairs. The humans who repair the machines also have kids and take sick days. If you need to send the robot out for service, a mover will pack it up and load it on a truck. Self-driving cars? Maybe someday, but not any day soon.&nbsp;Robots and made out of metals, which are mined out of the ground. Mineral deposits are not straightforward to find, to delineate and to mine. The discovery and extraction of mineral resources is a tremendously high-intellect activity. A small number of exploration geologists—many with doctoral degrees in fields such as geology and geophysics—have discovered a disproportionate fraction of mineable mineral deposits. Without labor, where would the metals come from to build the robots?&nbsp;Someone like Webb might respond that robots will replace all of these functions as well. And some day, they might. However, the replacement of humans by machines for one task creates a need for labor—with different skills—to operate the machines. That is why we now have jobs for truckers, power plant operators, and machinists instead of wood cutters.&nbsp;If miners were replaced with robots—how much labor would be required to build the robots including the entire supply chain, transportation, and the energy used to run them? It’s hard to say but a fraction of the impact would be shifts in the type of employment. Has the substitution of capital for human labor over the centuries since the industrial revolution has reduced overall employment? Not so much. We have far more need for labor now because we have accumulated so much capital and require more labor to operate it. The human population has increased—in lockstep with the demand for human labor—because we are so much more productive with our enormous legacy of capital goods that we can support much more population.&nbsp;Replacing the most routine and repeatable human labor with machines creates demand for the currently irreplaceable types of labor: creativity and problem-solving skills. It is true that boundaries of what machines can do expands over time. For example, voice recognition, which used to be quite poor, now handles a range of accents much better. However, AI is still at a point where it can at best replicate human learning by observing many samples created by humans. But for anyone who has tried to change their airline ticket by talking to a chat bot, it is clear that AI is at present limited to a standardized set of tasks.&nbsp;As we can afford it, out of our accumulated savings, capitalists will continue to invest in robots and other forms of automation to replace workers. When this results in cost savings, that means more output at a lower cost, and a rising standard of living. As certain goods become cheaper to manufacture, workers can demand other, new and different goods and services, which feeds the indirect demand for labor in those industries.

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Can robots and AI really make all the stuff for the elites after they have gotten rid of the people?

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Are Robots And AI Really Going To Displace All Workers?

Are Robots And AI Really Going To Displace All Workers? Probably Not

Despite crypto evangelists describing the current situation in the cryptocurrency market as just another dip, the phenomenon known as crypto winter has real and possibly lasting consequences for one of the more volatile finance sectors. As Statista's Florian Zandt details below, since May 2022, 38 companies in the crypto industry have laid off employees, among them crypto exchanges BitMEX and Coinbase, crypto service providers Crypto.com and Blockchain.com as well as NFT marketplace OpenSea.&nbsp;Now, 130 companies in the FTX Group owning the crypto exchange FTX have officially filed for bankruptcy due to a liquidity crunch caused by several factors. The chief reasons cited were increased user withdrawals starting November 6 and the revelation that Alameda Research, a company in the FTX Group, had a significant portion of its holdings in FTX's own FTT coin. Following this discovery, rival company Binance divested its FTT holdings, which caused the coin's value to fall drastically. According to now-resigned Chief Executive Sam Bankman-Fried, the company would have needed $9.4 billion to stave off collapse. As Statista's chart shows, the default of FTX could hurt a shaky-kneed crypto industry even further.&nbsp;<img src="/uploads/binance_dominates_crypto_graph_ff681304f0.jpg" alt="binance-dominates-crypto-graph.jpg">When looking at the year-to-date trading volume on the biggest crypto exchanges as aggregated by analysts at The Block, FTX ranks fourth behind Coinbase and OKX. No single exchange even comes close to Binance's trade volume though, with transactions amounting to $4.6 trillion between January and November 11. Its market leader position allowed Binance to be one of the first companies offering to bail out FTX, but the deal fell through as quickly as it was announced. "As a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged U.S. agency investigations, we have decided that we will not pursue the potential acquisition of FTX.com", the company announced on Twitter on November 9.&nbsp;FTX's scrambling to save its business and cryptocurrency valuations further careening downhill also caused U.S. lawmakers concern with calls for tighter regulations of crypto getting louder. "It is crucial that our financial watchdogs look into what led to FTX's collapse so we can fully understand the misconduct and abuses that took place," said Senate Banking Committee Chair Sherrod Brown. U.S. Senate Agriculture Committee chair Debbie Stabenow echoed that sentiment and added: "It is time for Congress to act. The Committee remains committed to advancing the Digital Commodities Consumer Protection Act to bring necessary safeguards to the digital commodities market."&nbsp;CZ is the king of crypto...

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The phenomenon known as crypto winter has real and possibly lasting consequences for one of the more volatile finance sectors.

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Binance Dominates Crypto Exchange Landscape

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