The Week Ahead: Earnings and Events

1. Hottest News This Week

📣 Joe Biden Drops Out

President Joe Biden has announced he will not seek re-election and has endorsed Vice President Kamala Harris for the 2024 race. This surprising move reshapes the upcoming election landscape. We'll have the whole story and more details in tomorrow's newsletter.

📣 Federal Reserve

Federal Reserve officials have entered a blackout period ahead of their next meeting. This week, they are prohibited from making public comments to ensure unbiased decision-making and avoid influencing markets.

📣 PCE

The June report on the personal consumption expenditures (PCE) index will reveal if inflation continues to decline, giving Federal Reserve officials crucial data before their late July meeting.

2. Matt Allen’s Corner

LTCM

In the late 1990s, the financial world witnessed the dramatic rise and catastrophic fall of Long-Term Capital Management (LTCM), a hedge fund that employed cutting-edge financial models and leveraged positions to achieve extraordinary returns. LTCM's story is a potent reminder of the risks inherent in relying too heavily on complex models and the dangers of excessive leverage.

The Rise of LTCM

LTCM was founded in 1994 by John Meriwether, a former Salomon Brothers bond trader with several esteemed partners, including Nobel laureates Myron Scholes and Robert Merton. The fund's strategy was based on sophisticated mathematical models to exploit pricing inefficiencies in the bond market. LTCM used arbitrage techniques to take advantage of minor price discrepancies between related securities, betting that these discrepancies would eventually converge.

Initially, LTCM was highly successful. The fund delivered exceptional returns, attracting investments from some of the world's most prominent institutions. By 1998, LTCM managed over $120 billion in assets and was considered one of the most prestigious hedge funds in the industry.

The Strategy and the Leverage

LTCM's strategy relied heavily on leverage. The fund borrowed vast sums of money to amplify its returns, often leveraging its equity by a factor of 25 to 1 or more. This high level of leverage meant that even small market movements could result in significant gains or losses. LTCM's models assumed that market conditions would remain stable and that correlations between different asset classes would hold. However, the financial markets are inherently unpredictable, and LTCM's assumptions would soon be tested.

The Beginning of the End

In 1998, a series of unexpected events unraveled LTCM's positions. The Asian financial crisis had already caused significant market volatility, and in August 1998, Russia defaulted on its debt and devalued the ruble. These events triggered a flight to quality, causing investors to sell risky assets and buy safer ones like U.S. Treasury bonds. This shift disrupted the pricing relationships that LTCM's models relied on, leading to massive losses.

As LTCM's position deteriorated, its leverage became a double-edged sword. The fund's losses were magnified, and it faced margin calls from its lenders. By September 1998, LTCM had lost nearly $4.6 billion in capital and was on the brink of collapse.

The Bailout

LTCM's potential collapse posed a significant threat to the global financial system. The fund's extensive network of counterparties and highly leveraged positions meant its failure could trigger a cascade of losses throughout the financial markets. Recognizing this systemic risk, the Federal Reserve intervened.

Under the guidance of the New York Federal Reserve, a consortium of major banks and financial institutions, including Goldman Sachs, Merrill Lynch, and JPMorgan, agreed to inject $3.6 billion into LTCM to stabilize the fund and unwind its positions orderly. This bailout averted a broader financial crisis but highlighted the financial system's vulnerability to the actions of a single, highly leveraged entity.

Cheers,

Matt Allen

3. Comin’ Up

EARNINGS AND ECONOMIC DATA

💰 Earnings:

Monday: Verizon, Ryanair

Tuesday: Alphabet, Tesla, Visa, Coca-Cola, Texas Instruments, Philip Morris

Wednesday: IBM, Thermo Fisher, ServiceNow

Thursday: AstraZeneca, AbbVie

Friday: Bristol-Myers, 3M

📈 Major Economic Events:

Monday: N/A

Tuesday: Existing Home Sales

Wednesday: New Home Sales

Thursday: GDP

Friday: PCE

The author of this newsletter owns ETF’s (exchange traded funds) that may hold ownership interests in the companies discussed in this newsletter as of the published date of this newsletter.