Elon Musk’s Twitter deal could be a landmark moment for vulnerable markets

The Fed is about to announce a 50 basis point increase in its policy rate and is expected to foreshadow both a series of similar moves throughout this year that would take the federal funds rate from near-zero to at least 2.5 per cent by the end of the year, along with the start of “quantitative tightening,” or a reduction in the $US9 trillion ($12.7 trillion) pile of bonds and mortgages it has accumulated since 2008 to pump ultra-cheap liquidity into the financial system.

That will be, as the RBA’s rate rise this week was for the Australian system, a landmark moment for not just the US financial system and financial markets, but the global system and markets. Surging inflation rates amid supply-side shocks from the pandemic and systems overloaded with liquidity have forced the central bankers’ hands.

With tech stocks having the most optimistic forecasts of their long-term prospects, they are – as this year’s performance of the Nasdaq market demonstrates – the most vulnerable.

With tech stocks having the most optimistic forecasts of their long-term prospects, they are – as this year’s performance of the Nasdaq market demonstrates – the most vulnerable.Credit:AP

Most vulnerable to rapidly rising rates are those who benefited most from ultra-low rates, notably technology stocks.

That’s because their value is arrived at by discounting their forecast future cash flows to calculate their net present value with an equation whose central input is the 10-year bond rate. As benchmark rates rise, net present values fall.

With tech stocks having the most optimistic forecasts of their long-term prospects, they are – as this year’s performance of the Nasdaq market demonstrates – the most vulnerable.

Musk has waded into the sea of risk and uncertainty the change in monetary policies is generating with what appears more like a vanity purchase than a hard-headed business decision, bidding $US44 billion that’s funded by a mix of debt secured by Twitter’s own assets and cash flows, his own cash (he sold billions of dollars worth of his Tesla shares last week) and debt whose collateral is provided by some of Musk’s shares in Tesla.

As rates continue to ratchet up and liquidity is withdrawn many investors, corporate executives and policymakers who have little experience of what “normal” monetary policy settings look and feel like are going to be tested. Some won’t enjoy that experience.

Twitter is loss-making and had negative cash flows last year but, if the deal completes, would now have to service a far bigger debt load. Tesla shares, which represent both Musk’s wealth and his ability to secure cash and funding for the deal, trade at more than 120 times earnings. While Tesla’s recent financial performance has been impressive, that makes its stock price vulnerable to the shift in monetary conditions.

Musk’s a successful risk-taker but taking on Twitter at such a delicate moment for financial conditions and markets is brave, or foolish. If he can’t dramatically improve Twitter’s financial performance it could end badly for him, Twitter and Tesla shareholders.

Of course, the change in the external settings won’t just affect Musk; the bid for Twitter is just the most prominent and current opportunity to consider how the radical and abrupt changes to monetary policies might have real-world impacts.

Absent a new twist to the pandemic, or a global geopolitical crisis flowing from the war in Ukraine, the course of the major central banks’ policies is set. It is being dictated to them by inflation rates that are the highest in decades and are likely to remain so until the central bankers quash them with rates a lot higher, and monetary conditions that are a lot tighter, than they are today.

Loading

That will inevitably have an impact on sharemarkets, bond markets and real economies that have become accustomed to, and complacent about, the prolonged period of unconventional monetary policies and ultra-low rates.

As rates continue to ratchet up and liquidity is withdrawn many investors, corporate executives and policymakers who have little experience of what “normal” monetary policy settings look and feel like are going to be tested. Some won’t enjoy that experience.

Source link

Check Also

Nearly 40% of investors who pulled money out of markets regret it

Moyo Studio | E+ | Getty Images Many investors who pulled money out of the …

Leave a Reply

Your email address will not be published.

 

SUBSCRIBE TO OUR NEWSLETTER

 

Get our latest downloads and information first. Complete the form below to subscribe to our weekly newsletter.