Monthly Archives: October 2013
In our last report, we highlighted the performance of credit markets. Well, last week, High Yield officially hit the 6% mark for returns year-to-date; an impressive feat after the mauling the asset class (and credit in general) took after mid-summer when QE taper talk had a runaway effect. What this means – other than the statistical note of 6% returns – is that since High Yield coupons average much less than 6%, the asset class has managed tighter spreads on the year to generate price action and ultimately overshoot its average coupon. This may be difficult to replicate in the months ahead since to begin with, the sector was frothy at the beginning of the year itself and even more so now. Thus, we may be at an inflection point of note. Also, new issues have been covenant-lite or covenant-free and investor protections have been at a low. In summary, it will be interesting to see how much more spread tightening the sector manages going forward – even with favorable demand for high yield debt in mutual funds and ETFs.
Some of the movers in credit last week were Financials (Toyota Motor Credit, Lincoln National, Credit Agricole) and Telecom (Verizon, TWC). In High Yield, most names were up, especially Sprint, AK Steel and beaten-down names like Edison Mission and RadioShack.
We tire of our notes on new issues but that bandwagon is still rolling merrily, as (still) low rates continue to bring issuers to the table and debt investors are seeking incremental return over treasuries. Bristol Myers Squibb and the World Bank were some of the notable issuers last week, with $7.5 billion between them.
Investment grade +72 bps over swaps (unchanged week over week)
High yield – 5.6% yield to worst (-20 bps better week over week)
Earnings have thus far been decent overall, although spots of weakness have been detected in sectors like retail (see McDonald’s sales miss for instance) or in Defense (Boeing losing orders to Airbus and Govt. shutdown as an example). Earnings season is still in gale force so we will keep an eye out for any large changes in sector strength/weaknesses. Observers are cognizant that the market is a pivotal point in terms of value and the fact that earnings have mostly galloped in response to cost-cutting rather than revenue generation.
Last week, as expected, stocks rebounded some 2% after a last-minute agreement in Washington to kick the can down the road or to temporarily relieve the debt ceiling. Credit markets did quite well also, in that wake; for the year, investment grade markets are still a tad under water (-1.5% or so, in returns YTD) but high yield is looking spiffy at +5.25%. Stocks are still the runaway winner, with double digit returns but with credit this frothy this year (even at the start of the year), it would have been difficult for credit to eke out anything but single-digit returns at best. Meanwhile, five-year swap rates (a great proxy for “AA” credit in general) also continues to climb down and is below 1%.
In some credit news, Crown Castle is taking over the cell tower business of AT&T. Probably makes sense as the wireless landscape is so competitive that it makes sense for specialization versus vertical integration. Barron’s outlined how AT&T stock now had a healthy dividend rate and ignored by equity investors: happens many times when equity and fixed income have divergent views on the same credit.
Investment grade +72 bps over swaps (-5 bps better week over week)
High yield – 5.8% yield to worst (-10 bps better week over week)
A whiff of hope that a shutdown would be averted led markets to strongly come back last week. The Dow was up 300 points and credit followed obediently, but muted in comparison (see spreads below).
Meanwhile even after the run-up in credit, the spread of high yield to treasuries (also known to mortgage observers more precisely as the OAS – option adjusted spread) is now at a recent low (+460 bps). Just as an observation, the super-low was close to 250 bps just after mid-2007; and investment-grade spreads (over swaps) went as low as +28 bps back then! Treasuries were higher-yielding back then, and total yields were of course, higher. But while that may be true, spread is spread and reflects relative luster between assets. I guess then, to make a long-winded point, market participants see this current spread wide-enough to justify backing up the trucks (funds and ETFs) periodically – when they have fresh cash – explaining much of the inflow and strength in the high yield market. And this reiterates another conviction as well: that while inflation remains tame and GDP growth sluggish, high yield is as good a place to park your money as riskier assets like stocks.
Investment grade +77 bps over swaps (-4 bps better week over week)
High yield – 5.9% yield to worst (-10 bps better week over week)
Yellen’s appointment definitely paves the way to a dovish leadership at the Fed but will she have more accommodation for the markets, given that Bernanke seems to have left the tap fully open. Perhaps more bond buying is one option or extending the buying program? If inflation creeps up to “acceptable” levels, that’s one way to have a legit mouse eat way at the debt outstanding.
For many months now, I’ve been postulating that “too big to fail” institutions have found a place in the buy side. And it was a prescient article today in the Wall Street Journal in the current account section of “money and investing” that said pretty much the same thing; that many trillion dollar institutions are now on the buy side and a “run on the banks” traditionally seen in sell side and retail banking could now happen on the buy side.
Markets seesawed, eventually ending the week a bit lower, as political discussions and negotiations continued in Washington. An interesting note in Barron’s was what we traders and investors would do if we had little or no data, since much of the data and metrics for the markets come from government agencies that are technically shut down.
In continuation of last week, 1-year CDS on US sovereign debt continued to widen, although at these levels (+53 bps), the smart money seemed to be transitioning to selling the CDS (or long US sovereign risk) or betting on an eventual capitulation in Washington. Also, interesting was that 1-year CDS (+53 bps) was trading higher than 5-year CDS (+41 bps); an inverted curve commonly found in distressed credits.
Other than the macro sovereign news, several names were in the news and were active. Edison Mission and Lloyds tightened in investment grade, and RBS continued its widening. JCP continued to be taken down across the capital structure and its paper (high yield) was down almost 4 points in the 5.65s ’20.
The new issue calendar continues to steam ahead, government shutdown or not. American Honda drove the field with 2.75 billion, in 3s, 5s and 3-yr frn. High Yield was relatively quieter but had a couple issues and two more to be priced this week (Michael Baker and NGL Energy).
Have a great week ahead!
Investment grade +81 bps over swaps (unchanged week over week)
High yield – 6% yield to worst (unchanged week over week)