Investment Grade Weekly Insights 01/05/2018

Fund Flows & Issuance: According to Wells Fargo, IG fund flows for the week of December 28-January 3 were $3.0 billion, the largest inflow in six weeks. Per Bloomberg, investment grade corporate issuance for the week through January 4 was $21.05bln. As of today, the Bloomberg Barclays US IG Corporate Bond Index is trading at an OAS of 94, which is +1 from the 2017 tight of 93. In 2007, spreads bottomed at an OAS of 82. The all-time tight is 54, which occurred in March of 1997.

(WSJ) Who Are the Big Players in the Bond Market? Small Investors

• Ordinary investors are a growing force keeping longer-term bond yields low, even as the Federal Reserve has raised interest rates. They are helping cap borrowing costs for individuals, corporations and state and local governments, while boosting the appeal of riskier assets such as stocks, which have climbed to record after record in recent months.
• John Nederhiser exemplifies the current crop of bond buyers. While professional money managers fret about interest-rate increases, rising budget deficits and inflation, the 58-year-old accountant in Gresham, Ore., said such concerns won’t deter him from continuing to add to his fixed-income holdings. “Pretty much what I’m going to do is stay the course,” he said.
• An aging population means investors like Mr. Nederhiser are likely to remain a factor, as people typically increase bondholdings as they approach retirement. The population of U.S. residents age 65 or older has grown more than 40% since 2000 to 49.2 million in 2016, according to the Census Bureau, which could signal steady demand for the debt. The median age for investors with fixed-income holdings ranging from mutual funds to individual bonds is 53, according to the Investment Company Institute’s annual mutual-fund shareholder survey, up from 49 in 2007.
• Some older investors have lived through periods where inflation climbed above 10% and where it cratered below zero, while watching plunges in technology stocks and home prices dent their accumulated wealth. For some, that has led to a pragmatic appreciation of bonds’ steady income and relative stability.
• The sanguinity of ordinary bondholders stands in contrast with 2017 statements from some more famous investors such as Bill Gross and Jeff Gundlach, both dubbed “the Bond King” at various times. Mr. Gross and Mr. Gundlach each created a stir last year by intimating a broad selloff might be approaching.
• Much of the support individual investors are giving to the Treasury market is as a result of their investments in diversified bond funds, not an insatiable hunger for government debt. That is because government debt now makes up more than one-third of the Bloomberg Barclays U.S. Aggregate bond index, a popular reference point that guides how many portfolio managers assemble their holdings.
• The amount of Treasurys in the index has risen from roughly one-quarter in 2007, before the financial crisis led to an explosion in government borrowing and a slowdown in issuance from corporate and mortgage borrowers. The proportion of Treasurys may rise further as the Fed pares back its $4.2 trillion in holdings of government and mortgage debt, which indexes don’t count since the Fed’s portfolio sits outside of the open market.
• With government bond yields already near modern lows, some analysts see complacency as among the biggest risks. And some investors find it difficult to settle for single-digit bond yields when the S&P 500 index has posted double-digit returns for the seventh time in the past nine years.
• It remains to be seen if retail investors will hang on to bonds should yields start to skyrocket. During the 2013 “taper tantrum,” which followed then-Fed Chairman Ben Bernanke’s statement that the central bank was preparing to stop its bond purchases. Bond funds suffered net outflows for eight consecutive months afterward, while the yield on the 10-year note almost doubled to around 3%.

(Barron’s) Intel: Don’t Anticipate Any Impact to Business

• Intel (INTC) executives this afternoon held a conference call to address reports today, initiated by The Register, that the company had a “bug” or flaw in its chips that raised security issues, a charge the company had this afternoon rejected.
• Led by Intel executive Steve Smith, the head of the company’s data center engineering, the company said repeatedly its chips are “performing as designed” and that info appearing today had contained mis-information.
• “There were some info in media that was, I’ll call it, ahead of time,” said Smith, referring to the fact Intel said it had been working “for some time now” with security researchers and with operating system vendors and computer makers to prepare “mitigation” of security risks. The reports in media were “potentially misleading,” said Smith, “so wanted to clarify.”
• Added Smith, “Since our products are performing to specification, we don’t anticipate a material impact to our business or our products, because they continue to operate properly.”
• “We don’t expect any financial implication around Intel’s products,” Smith later reiterated.

(Bloomberg Markets) Morgan Stanley Wealth Exits Junk Bonds, Warns on Recession Risk

• It’s too late in this market cycle to bet on high-yield bonds, according to Morgan Stanley Wealth Management.
• So, the $2 trillion money management arm is completely slashing junk bond allocation. True, tax cuts are expected to inject fresh momentum into high-flying stocks, but the boost may be short-lived and mask balance-sheet weaknesses, Mike Wilson, chief investment officer, wrote in a note distributed Wednesday.
• “While the tax cuts just enacted in the U.S. may lead to better growth in the short term, they may also bring forth the excesses we typically see before a recession — which is something credit markets figure out before equities,” according to the note. “We recently took our remaining high yield positions to zero as we prepare for deterioration in lower-quality earnings in the U.S. led by lower operating margins.”
• Though Morgan Stanley doesn’t expect a recession in 2018, it sees the risks rising. Between tightening monetary policy and fewer positive surprises in earnings and economic data, any remaining upside is likely to be speculative, according to the firm.
• “We think it will be much tougher to make money in 2018 and 2019 than in 2016 and 2017 as the risk of a recession and outright bear market comes closer,” Wilson wrote. “Late-cycle dynamics have become even more evident.”