Spreads are likely to finish wider for the second consecutive week. The OAS on the corporate index is at 124 this morning after closing the prior week at a spread of 120. Spreads opened the previous week at 113, so the move wider in credit has been meaningful over the course of the past two weeks, but this move has largely been overshadowed by lower Treasuries. The 10yr is wrapped around 1.54% as we go to print after having closed the week prior at 1.74%. The 10yr closed the month of July at 2.01%. The move lower in rates has been quick and intraday ranges have been volatile with the 10yr trading below 1.5% on Thursday while the 30yr traded below 2% for the first time in history. For all the volatility in rates and spreads the corporate market has a positive tone as we go to print Friday morning. There are not many sellers of corporate credit while buyers are plentiful. This has made it difficult to find attractive bonds in recent weeks but we at CAM are chipping away and finding select opportunities in credit.
The primary market continues to show resiliency amid a volatile tape. Corporate borrowers brought $23bln in new debt during the week, pushing the month to date total north of $64bln. According to data compiled by Bloomberg, year-to-date corporate supply stands at $754.7bln, which trails 2019 supply by 6%. The primary is set to enter a quiet period for the final two weeks of August before ramping up after Labor Day. September has historically been among the strongest months for the new issue calendar.
Fund flows into investment grade corporates were strong for the second consecutive week. According to Wells Fargo, IG fund flows during the week of August 8-14 were +$5.4bln. This brings YTD IG fund flows to +$174bln. 2019 flows to this juncture are up 6.7% relative to 2018.
(Bloomberg) Investors Rushed to High Grade as Recession Fear Spooked Markets
Investors dove into U.S. investment-grade corporate bond funds during a week when fears of a global economic slowdown rose and trade-related headlines brought wild swings in stocks, credit and Treasuries.
Investors plowed $4 billion into high-grade funds for the week ended Aug. 14, according to Refinitiv’s Lipper. It was the biggest inflow since June, as U.S.-China trade headlines continued to rattle markets and concerns about a slowing global economy inverted a key portion of the U.S. Treasury yield curve for the first time in 12 years. High-yield funds posted a modest inflow of $346 million.
Investment grade has become the best performing asset class in fixed income with returns of over 13% so far this year, according to the Bloomberg Barclays US Corporate Total Return index.
The high-grade primary market has also remained steadfast during the volatility in recent weeks. With the exception of Wednesday, when issuers sidelined themselves during the rout, debt borrowers have been able to sell bonds at cheaper funding costs.
Last week investors yanked over $4 billion from junk bond funds, the most since October, while adding $2.8 billion to high-grade funds.
Spreads in the corporate market are set to finish the week meaningfully wider as the OAS on the index opened at 113 on Monday and is trading at 119 as we go to print on Friday morning. Rate volatility was as the forefront this week as the rates market has more carefully considered the impact of a full blown trade war. The 10yr Treasury closed at 1.85% last Friday and is wrapped around 1.70% as we go to print this morning. Spreads opened the month of August at year-to-date tights of 108 and have now moved 11 wider, but at the same time the 10yr Treasury is 30 basis points lower, so the net effect is lower yields for corporate credit. While the Fed cut the federal funds rate by 25bps last Wednesday, the market expectation is that this is merely the beginning of a multi-cut easing cycle. Federal funds futures are now implying 2 additional cuts by the end of 2019 and 2 more by the end of 2020. At CAM, we are of the belief that it is quite possible that markets are underestimating the probability of a lack of near term trade resolution and the associated impact that a prolonged trade dispute could have on risk assets.
Even amid heightened volatility and uncertainty, the primary market was quite active during the week. In fact it was the fifth busiest week of the year that also saw Occidental Petroleum print the 4th largest bond deal of the year which was met with robust investor demand. While spreads are set to finish the week meaningfully wider it is clear that there is solid demand for corporate credit, particularly higher quality issuers. According to data compiled by Bloomberg, year-to-date corporate supply stands at $731.9bln, which trails 2019 supply by 6%. It is worth noting that for most of 2019 supply has trailed 2018 by 10-12% but this gap has narrowed in recent weeks. The M&A pipeline continues to grow and it would not surprise us at CAM if issuance were robust through the end of September which could continue to push issuance totals toward 2018 levels.
Fund flows into investment grade corporates escalated throughout the week. There was a clear bifurcation between the high yield and investment grade credit markets as flows during the week were driven by a flight to quality. According to Wells Fargo, IG fund flows during the week of August 1-August 7 were +$3.3bln while high yield funds experienced losses of -$3.7bln over the same time period and leveraged loan funds posted outflows of -$963 million. This brings YTD IG fund flows to +$169bln. 2019 flows to this juncture are up 6.5% relative to 2018. The fact that flows are up while new issue supply is down is but one factor that has led to a supportive environment for credit spreads.
The corporate market was modestly wider on the week with the spread on the index 1 basis point wider week over week as we go to print on Friday morning. Spreads have largely been in a holding pattern for the month of July, as the index opened the month at an OAS of 115 versus a 113 close yesterday evening. The 10yr Treasury continues to hover just above 2% amid dovish commentary from Federal Reserve officials. Media blackout begins tomorrow for Fed officials so we will get a respite from commentary until after the July 31 FOMC decision.
It was a quiet for the primary market as less than $15bln in new corporate debt was brought to the market which was underwhelming relative to the $30bln consensus figure. According to data compiled by Bloomberg, year-to-date corporate supply has topped $600bln, which trails 2019 supply by 10%.
Fund flows into U.S. corporates escalated throughout the week. According to Wells Fargo, IG fund flows during the week of July 11-July 17 were +$4.8bln. This brings YTD IG fund flows to +$158bln. 2019 flows to this juncture are up 6.1% relative to 2018.
(Bloomberg) After Times Square Goes Dark, NYC’s ConEd Faces More Heat
It lasted all of five hours — and hit just the spot on New York’s power system to take out the lights in Times Square, force the evacuation of Madison Square Garden in the middle of a Jennifer Lopez concert and bring parts of the city’s subway system to a screeching halt.
The Saturday evening blackout on Consolidated Edison Inc.’s grid — extending from about Fifth Avenue to the Hudson River and from the 40s to 72nd Street — was so widespread that it took out much of Midtown, Hell’s Kitchen, Rockefeller Center and the lower reaches of Manhattan’s Upper West Side. Now ConEd, already under fire because of other mechanical breakdowns in recent years, is facing renewed calls to overhaul its network.
The power failure struck on the anniversary of the historic 1977 blackout that led to widespread looting and other crimes across New York City. And it peeled back disparities between old technology and new: halted subways meant a $2.75 fare ballooned to a $57 Uber primed to surge pricing.
Just over six months ago, ConEd was facing an investigation after an electrical fire at a substation turned New York City’s night sky blue, temporarily disrupting flights and subway services. In July 2018, it was the subject of a probe after an asbestos-lined steam pipe ruptured in Manhattan’s Flatiron district. And a power failure in 2017 led to significant delays on the subway during a morning commute, triggering an investigation that cost the company hundreds of millions of dollars.
ConEd Chief Executive Officer John McAvoy told reporters late Saturday that the company would investigate the root cause of the event and “restore the system to a fully normal condition once we understand what exactly occurred.” He said the power failure didn’t appear to be weather-related. Hot weather typically sends power demand surging as people blast air conditioners.
(WSJ) Cellphone Tower Companies Race Higher
As the biggest wireless companies in the U.S. prepare to bring 5G to more customers, cellphone-tower operators are shaping up to be big winners in the stock market. They could be ready to get another boost if or when the deal between T-Mobile US Inc. TMUS -0.37% and Sprint Corp. S +0.37% closes, some analysts say.
Shares of Crown Castle International Corp., American Tower Corp. and SBA Communications Corp. all hit records in 2019, and are currently up at least 20% from where they traded six months ago. Cellphone companies like Verizon, AT&T and T-Mobile pay these tower companies fees to use their high-up real estate.
A concern among some investors is that these companies soared too high too fast. Of the trio, only shares of SBA Communications have risen in the past month. Part of the reason for that is a slowdown in talks between T-Mobile and Sprint.
While final conditions for the merger deal remain to be seen, a key component of the Federal Communications Commission’s conditions is an accelerated 5G rollout in rural areas, UBS notes. That stands to benefit American Tower most, as about 65% of its macro portfolio covers the most rural part of the U.S., according to a research report by UBS last month that looked at the FCC’s antenna registration database of tower locations throughout the U.S.
Another potential overhang has been worries that private operators could be competition for these three big public tower owners as wireless carriers seek out lower rents. However, UBS’s report also found that the big three public tower companies remain the dominant players in a hot business, with the largest private owner of tower sites accounting for just about 2% of all towers. That bodes well for SBA Communications, American Tower and Crown Castle.
“While the private operators have increased their tower counts…this competitive threat is far more limited in practice at this time,” UBS said in its note.
(Bloomberg) A Leveraged Loan Collapses and Reveals Key Risk in Credit Market
Operating out of a Chicago suburb, in a low-slung, red-brick building wedged between a Hyatt and a Radisson, Clover Technologies is in the mundane business of recycling everything from inkjet cartridges to mobile phones.
But in the past week it abruptly — and alarmingly — caught the attention of Wall Street. Almost overnight, a $693 million loan Clover took to the market five years ago lost about a third of its value. The startling nosedive stung even sophisticated investors, people who deal in the arcane business of trading corporate loans.
Clover’s loan isn’t especially large by Wall Street standards, yet its stark and swift decline set off fresh alarm bells — bells that regulators have been sounding for months. It immediately became a real life example of the perils of investing these days in the $1.3 trillion market for leveraged loans, where a global chase for yield has allowed an explosion in borrowing and lax underwriting. In a market where trading can be thin — and at a time when illiquidity is suddenly becoming a prominent concern in credit circles — the episode shows how loans to highly leveraged companies can quickly implode when fortunes change.
Using the leveraged loan market as a wallet, the company took loans that funded dividend payments totaling at least $278 million — $100 million in 2013 and $178 million in 2014. (Portions of the overall proceeds went to shareholders as well as to refinance the company’s existing debt and certain fees, according to a Moody’s report.) Clover also asked lenders for a further $100 million in 2014 to pay for an acquisition.
Those loans, as is typically done, were bought mostly by mutual funds and collateralized loan obligations, which bundle such leveraged debt into higher-rated securities that are pitched to more risk-averse investors. There’s been little trouble finding buyers for CLOs in recent years. With yields on high-grade bonds hovering near zero across much of the world, investors have been hungry for the juicy returns that these loans offer and, more and more, tend to overlook the lack of protection afforded.
Moody’s now predicts a higher likelihood Clover will default on its debt obligations. The ratings agency cites concerns over long-term viability of the business and “unexpected” operational developments. Its debt is just over 6 times its earnings, a level that typically raises lender concerns about the company’s ability to meet its financial obligations. Another warning sign came in May when the company pulled a seemingly attractive refinancing plan that offered a high yield of nearly 9% with a short, three-year maturity.
Investors may recall similar blowups in the credit market. American Tire Distributors’ bonds and loans plunged into distress less than a month after it announced the loss of two key suppliers, Goodyear and Bridgestone. ATM-maker Diebold Nixdorf Inc. also saw its bonds fall to almost half their face value after it posted an unexpected second quarter loss.
The investment grade credit market continued to perform well during the second quarter of the year. The Bloomberg Barclays US Corporate Index opened the quarter at an option adjusted spread of 119 and traded as tight as 109 by mid-April before ending the last trading day of June at a spread of 115. Lower quality credit modestly outperformed during the quarter with the BBB-rated portion of the index tightening by 7 basis points relative to the A-rated portion which tightened by 3 basis points. The bigger story of this quarter was lower Treasury yields as the 10yr Treasury finished the quarter 40 basis points lower than where it started. The 10yr ended the first 6 months of 2019 at 2.005% after closing as high as 2.78% in the first few weeks of January. Tighter spreads and lower Treasuries have combined to yield strong performance for investment grade creditors. The Bloomberg Barclays US Corporate Index posted a total return of +9.85% through the first 6 months of the year. This compares to CAM’s gross return of +9.20% for the Investment Grade Strategy.
When Doves Cry
As longtime clients and readers know, at Cincinnati Asset Management we avoid speculating on the direction of interest rates. Instead we direct our efforts to bottom up credit research, thoroughly studying individual credits and diligently following industry trends, then opportunistically sourcing bonds which can add the most value to the overall portfolio. By positioning the portfolio with intermediate maturities ranging from five to ten years, we mitigate a significant portion of interest rate risk as investors are generally rewarded over medium and longer term time horizons by avoiding tactical positioning and the downside that can come about from being too short or too long with duration bets gone awry. However, while we may be interest rate agnostic, we are not interest rate blind. We would be remiss if we did not comment on the policy actions that we have seen out of the Federal Reserve thus far in 2019. Simply put, the Fed continues to exceed the dovish expectations of the market, a remarkable feat given the extent that the market is pricing in rate cuts, with Fed Funds futures data implying a 100% probability of a rate cut at next FOMC decision on July 31i. We take this as a sign from the Fed that it is extremely concerned with managing a so called “soft landing” when the current economic expansion finally runs out of steam.
The actions of the Fed do not occur in a vacuum and they can have a significant impact on risk assets such as corporate credit. Lower Fed Funds rates coupled with the potential for future slowing economic growth can lead to lower risk-free rates (Treasury rates). When risk-free rates are low, yield starved investors from around the globe turn to large liquid markets in order to satiate their thirst for income thus setting their sights on the corporate credit market. Defaults remain nearly non-existent in the investment grade universe, and when coupled with a still growing economy, this can be a recipe for complacency and a tendency to “reach” for yield. Investors can reach for yield in two ways in IG credit; they can either extend duration or they can take on additional credit risk, but they usually do both. These are ill-advised strategies in our view, especially for investors concerned with capital preservation over a long time horizon. As far as extending duration is concerned, the compensation afforded for extending from a 10yr bond to a 30yr bond typically pales in comparison to the additional interest rate risk that is incurred. What most investors fail to realize is that most duration extensions also contain a significant dose of credit risk. Take the following example with Comcast’s 10yr and 30yr bonds:
An investor receives just 87 basis points of extra compensation for purchasing Comcast’s 30yr bond versus its 10yr bond, and in exchange, the investor takes on an additional 9.4yrs of duration risk. This means that if there is a linear shift in the yield curve and interest rates increase by 100 basis points, the investor in the 30yr bond will capture an additional nine points of downside. However, duration alone does not tell the whole story, as this is not just a story about interest rate risk as much as it is also a story about credit risk. Our hypothetical investor could purchase the risk-free rate instead of the corporate bond, and as you can see from the example above, the spread between the 10 and 30 year Treasury is 53 basis points. If we subtract this 53 basis points from the 87 basis points in spread between the Comcast 10yr and 30yr the difference is 34 basis points. Therefore, 34 basis points is the compensation that the investor receives for the additional credit risk incurred for the purchase of the 30yr Comcast bond in lieu of the 10yr Comcast bond. We like Comcast as an in investment. It is a best-in-class operator in its industry and it generates tremendous free cash flow. But we do not like it enough to lend it money for an additional 20 years in exchange for just 34 basis points of compensation for that credit risk. It simply does not make much sense to us from a risk-reward standpoint.
If you have not yet nodded off from this exercise in corporate credit, the other aforementioned avenue for increasing yield is to simply take on more credit risk by buying shorter maturity bonds of companies with marginal credit metrics. Usually the bonds of companies with marginal credit metrics will offer outsize compensation relative to the bonds of companies with stable or improving credit metrics. There is almost always a reason that the bonds of a marginal company will offer more yield but an investor really has to dig into the numbers and the industry to understand why. Sometimes it may simply be a case of a company that has too much debt or perhaps the business is showing signs of deterioration. Sometimes these investments may well work out but it only takes one or two permanent impairments (downgrade to high yield, structural subordination, default or fraud) to severely impact the performance of a bond portfolio. Taking on more credit risk is not worth it in the current environment in our opinion and is one of the reasons we are significantly structurally underweight the BBB and lower-rated portion of the investment grade universe. We cannot accurately predict when the business cycle will contract but we most assuredly are viewing all new and current investments through a late-cycle lens as we populate the portfolio with companies that have durable business models and the ability to generate free cash flow and comfortably service debt in a recessionary environment.
BBB, Leading the Way
The lowest quality component of the investment grade universe has significantly outperformed the higher quality portion thus far in 2019. The OAS for the index as a whole was 38 basis points tighter through the end of the second quarter. If we segment that by credit quality, the A-rated portion of the index was 30 basis points tighter while the BBB-rated portion of the index was 51 basis points tighter.
Much has been written about the growth of BBB-rated credit, and for good reason. At the end of 2008 it represented 33.15% of the index but at the end of 2018 that figure had swollen to 51.21%. We cap the exposure of our portfolios to BBB-rated credit at 30%, thus we are much more conservatively positioned than the index. We think that this conservative positioning is especially crucial in times like these and we have no intention of increasing our exposure in the near term.
What Happened to Regulators Looking out for the Little Guy?
We typically avoid commenting on regulatory matters but an SEC proposal that was greenlighted in the second quarter has us flummoxed. Regulators recently approved a pilot program that shows a blatant disregard for retail investors and financial advisorsii. Trade disclosure in the corporate bond market has come a very long way in the past 15 years. It is still an over-the-counter market but there was a time in the not too distant past when it was rife with opacity in that there was simply no record of the price at which a bond was traded. The market has slowly but surely evolved and today there is an electronic record of where all corporate bonds trade within 15 minutes of when the trade was completed.
An SEC committee comprised mostly of the largest asset managers and broker dealers on the street voted to enact a 1-year pilot proposal that would roll back much of the progress that has been made with trade disclosureiii. The proposal centers on “block” or large bond trades. The current rule for IG corporate bonds caps trade size dissemination at $5 million but the trade must be posted within 15 minutes. So, as the rule stands today, a trade could have been completed for $50 million of a specific bond issue but unless you are privy to the details you will only know that at least $5 million traded and you will know at what price and you will know this information within 15 minutes of trade completion. This provides some (and we would argue more than adequate) protection to dealers who can buy a large block of a bond from an asset manager and then sell the bond to other asset managers over time without other market participants knowing that the dealer owns a large amount of that particular bond issue. The pilot proposal would increase the dissemination cap to $10 million, and unbelievably, would allow for up to a 48-hour delay (!) before the trade is reported. We oppose the proposal in its entirety as we believe markets are more efficient with more, not less, information, but we take particular issue with the reporting delay. Ironically, the proposal arguably helps us at CAM because it makes the professional management we provide even more valuable. It will not impact our ability to affect best execution because we are in the corporate market all day every day and have many resources and relationships at our disposal to determine where bonds should trade but the proposal is debilitating to the ability of an individual investor or advisor to engage in price discovery.
To understand the potential real-world implications imagine a scenario where Cincinnati Asset Management (CAM) sells $12 million of a particular bond to a dealer at $100. Remember, the trade does not need to be posted for two days. In the interim you, the reader, log into your brokerage account intending to purchase that same bond. You see a price of $105 offered to you, and see no other trades have posted for this particular bond. CAM’s hypothetical $12 million trade has yet to be reported, and you have no way of knowing about it. That $105 price looks fair to you so you purchase the bond. Shortly thereafter the broker-dealer sells the bonds they bought from CAM at $100.25 and both trades are publicly posted. Now you can see that the bond just traded $100-$100.25 and suddenly it appears that you overpaid. But how could you have known if you are not armed with adequate information? This is the proposal in a nutshell – temporarily hiding data from public view for the benefit of a privileged few.
As far as we can tell the only purpose of this proposal is to provide liquidity to large asset managers at the expense of small investors and to enrich the largest broker dealers on the street. Even if it may help us we are still against this proposal as it stands today because it is simply unfair and it is a step back for the corporate credit market. We believe that transparency is necessary for healthy and fully functioning capital markets and that this transparency is the only way to make the market fair to investors of all types, both large and small.
Looking Ahead
As we turn the page to the second half of the year we see more uncertainty ahead. Global trade continues to dominate the headlines and investors are becoming increasingly concerned about economic growth in the Eurozone. As we go to print with this letter the German 10yr Bund is trading at a record low of -0.36%iv. Geopolitical risk too is at the forefront as tensions between the U.S. and Iran remain high. Although the investment grade credit market has performed quite well to start the year we plan to remain conservative in the positioning of our portfolio. We welcome any questions, comments or concerns. Thank you for your continued interest and support.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
i Bloomberg, July 1, 2019, 2:08 PM EDT, World Interest Rate Probability (WIRP)
ii FINRA Requests Comment on a Proposed Pilot Program to Study Recommended Changes to Corporate Bond Block Trade Dissemination, April 12, 2019, https://www.finra.org/industry/notices/19-12, Accessed July 1, 2019
iii The Wall Street Journal, June 27, 2019, Bond Fight Pits Main Street Against Wall Street
iv CNBC, July 2, 2019, German 10-year bund yield falls to record low, US Treasurys stable amid softer GDP outlook
It was a bit of a see-saw week in the corporate market as the tone was very heavy on Monday but sentiment turned decidedly more positive on Tuesday and remained so throughout the rest of the week. The OAS on the corporate index opened the week at 128 and widened to 130 going into Tuesday morning but we sit back at the 128 level as we go to print on Friday morning. The biggest story of the week is Treasury yields, which are lower across the curve for the second consecutive week. The 10yr Treasury is over 5 basis points lower on the week and sits at its lowest level of 2019 and the lowest levels we have seen since September 2017.
$23.4bln in new corporate debt was brought to the market this week. New issue concessions remain low, having averaged 3.5bps thus far in 2019 according to data compiled by Bloomberg. Of course, every deal is different and some deals have enjoyed more substantial concessions than others. Year-to-date corporate supply has crossed the half trillion mark and sits at $511.1bln, which lags 2019 issuance by over 9% according to data compiled by Bloomberg.
According to Wells Fargo, IG fund flows during the week of May 30-June 5 were +$6.2bln. This brings YTD IG fund flows to +$125bln. 2019 flows to this juncture are up 4.8% relative to 2018.
(Bloomberg) Fiserv’s Expected Jumbo M&A Deal Makes an FX Pivot
A highly-anticipated Fiserv jumbo M&A bond deal never materialized Thursday as the company announced plans for a European roadshow, calling into question how big the dollar leg will be. Many had expected up to a $12 billion transaction funded solely in the U.S. currency. Meanwhile, two deals moved forward pricing $810 million.
While it didn’t bring a deal, Fiserv did, unexpectedly, announce a EUR and/or GBP roadshow just as Mario Draghi was declaring that the ECB won’t shy away from action to support the euro-area economy during a period of weakening growth. A dovish ECB and low rates potentially going lower may have contributed to Fiserv’s decision to test alternative currencies. We have seen a surge in reverse yankee issuance for exactly this reason
The stage seemed set for Fiserv to bring high-grade’s first jumbo deal since Bristol-Myers and IBM priced nearly $40b in acquisition-related funding for Celgene and Red Hat, respectively. Equity futures were in the black, IG CDX opened tighter and Wednesday’s two biggest deals from HCA and Parker-Hannifin were trading though new issue levels after achieving strong primary pricing outcomes. From an economics perspective, if you’re a believer in the correlation of ADP and nonfarm payrolls, Thursday offered a brief window ahead of a potentially weak jobs report. This, all amid an irrefutably stronger primary market backdrop that had steadily improved over the week.
Should Fiserv elect to predominantly tap the European debt capital markets it will be the second time in under a month that an issuer bringing an M&A deal has gone overseas for the majority of the funding. Fidelity National Services elected to fund just USD1b after launching EUR5b and GBP1.25b for their Worldpay acquisition. People with knowledge of the deal expected a much larger greenback portion. So much so that the USD-leg was more than 8 times oversubscribed in less than two hours.
(Bloomberg) U.S. Payrolls, Wages Cool as Trade War Weighs on Economy
S. employers added the fewest workers in three months and wage gains cooled, suggesting broader economic weakness and boosting expectations for a Federal Reserve interest-rate cut as President Donald Trump’s trade policies weigh on growth.
Nonfarm payrolls rose 75,000 in May after a downwardly revised 224,000 advance the prior month, according to a Labor Department report Friday. The increase missed all estimates in Bloomberg’s survey calling for 175,000. The jobless rate held at a 49-year low of 3.6% while average hourly earnings climbed 3.1% from a year earlier, less than projected.
The dollar and Treasury yields fell as the data signaled the labor market — a pillar of strength for an economy headed for a record expansion — was facing new pressures even before Trump threatened tariffs on Mexican goods in addition to proposed higher levies on Chinese imports. Retail sales, factory output and home purchases have shown the economy struggling this quarter after better-than-expected growth in the first three months of the year.
(Forbes) Intel Charts A New Course With 10th Gen Core And Project Athena
Likely the most anticipated product that Intel revealed at Computex was its 10th Gen Core processors code-named Ice Lake. These 10th Gen Core processors utilize a new Sunny Cove CPU architecture and are built with Intel’s much awaited 10nm process node, which previously had some issues regarding yields that Intel claims are now resolved. Intel says these issues are behind them and that we can see volume production of 10nm with this 10th Gen of Core processors. These new Ice Lake processors also feature the new Gen11 graphics chip, which should elevate Intel’s performance in integrated graphics further to enable even better entry-level gaming. The 10th Gen Core processors announced at Computex range from Core i3 up to Core i7, with up to 4 cores and 4.1 GHz max turbo frequency. These processors target 2-in-1 and thin and light laptop form factors, so having a 4.1 GHz max turbo frequency AND 1.1 GHz GPU frequency is quite impressive.
Intel claims the Iris Plus graphics inside of the 10th Gen core processors (based on their Gen11 graphics) provide double the performance over the previous generation in some benchmarks. The company also claims double the HEVC encode performance, which should help with creative people wanting to do on-the-go video editing. Additionally, Intel claims double the FPS in 1080P games. While this would obviously be a pretty significant improvement, it will likely depend heavily on how the thermals are managed by the device manufacturer and over what period.
Intel also integrated both Thunderbolt 3 and Wi-Fi 6 into the 10th Gen Core processors, which is a pretty big deal for those who care about connectivity. Wi-Fi 6, formerly known as 802.11AX, is the future of Wi-Fi and will bring significant improvements to the quality of service, performance, and efficiency. Intel and others are doing the industry a favor by aggressively pushing the standard. Integrating Wi-Fi 6 will help to increase the adoption of Wi-Fi 6 and improve the user experience of PC users. The more users with Wi-Fi 6 devices on a Wi-Fi 6 network, the more efficient the network becomes. Everyone’s speeds (including non-Wi-Fi 6 users) go up. There are also coverage and quality benefits to Wi-Fi 6, but those are more dependent on the access point. Thunderbolt 3’s integration is also important because it is an incredibly versatile high-bandwidth interface that helps improve a device’s modularity with things like docks, displays, and drives.
OEMs will launch systems with the 10th Gen Core processors this holiday season, which is a bit later than one would expect with a May announcement. With the new process node and design principals, the 10th Gen Core processors are poised to usher the company into a new era.
(Bloomberg) Duke Energy Gets Nod From Indiana Regulator for Solar Pilot
Duke Energy received approval from the Indiana Utility Regulatory Commission for a pilot program that allows some customers lease solar energy facility from Duke for up to 20 years.
Initial capacity limited to total of 10 megawatts for customers
Duke installs, operates, owns and maintains facility
Customers receive all of the kilowatt-hour output of solar energy equipment through net-metering arrangement
The tone in the credit markets was mixed this week. The market felt heavy on Tuesday amid trade ramifications but by the time Thursday rolled around the tone was quite strong. All told it looks as though we will finish the week relatively unchanged as far the spread on the index is concerned. There are more negative headlines regarding China trade as we go to print on Friday which is leading to weakness in equity markets while Treasury’s are gaining. The 10yr is modestly lower on the week and remains below 2.4% on Friday morning.
Just under $30bln in new corporate debt was brought to the market this week. Demand for new issuance has been solid and thus concessions were low, in the neighborhood of 3-5 basis points for most deals. Year-to-date corporate supply is up to $468bln, which lags 2019 issuance to the tune of -6.3% according to data compiled by Bloomberg.
According to Wells Fargo, IG fund flows during the week of May 9-May 15 were +$4.2bln. This brings YTD IG fund flows to +$114bln. 2019 flows to this juncture are up 4.43% relative to 2018.
(Bloomberg) Bond Traders Need to Up Their Game as AI Systems Get Smarter
Money is pouring into artificial intelligence in bond markets, challenging bankers and investors to adapt their skills in everything from issuing to trading securities.
Fintech startup Nivaura is investing in technology to automate debt sales. Dutch bank ING Groep NV is improving systems to help traders buy and sell bonds, while AllianceBernstein Holding LP advanced its virtual assistant to identify notes that people miss.
After taking over stocks, computers are slowly overcoming resistance in one of the most technology-averse corners of financial markets. Bond traders are wary of a one-size-fits-all approach coming from equity markets, which are now largely automated. They say that human relationships are at the center of the market and clients want to talk through complex transactions.
AI has proved particularly useful in replacing manual tasks such as inputting data and executing small, liquid trades in markets such as currencies. It’s only just beginning in areas like corporate bonds, that traders call “high touch” for the traditional level of human involvement.
Still, proponents say tech is being used as a tool by people rather than a replacement for them and that it helps firms use human resources more efficiently.
(Bloomberg) In a Tariff-Muddled World, U.S. Treasuries Send a Clear Message
Investors are wrestling with mixed U.S. data, underwhelming global growth, and an escalating trade war. While other asset classes have telegraphed optimism, sovereign debt is signaling a degree of caution, if not abject fear, about what comes next.
While U.S. stocks are barely down on the week through Thursday after collapsing on Monday, Treasury yields are decisively lower. Bund yields aresolidly sub-zero. Chinese sovereign debt is being heralded as a clear winner in the clash over cross-border commerce.
Another note of caution for Treasury bulls betting on an extension of the rally: expectations that the Federal Reserve is poised to ease – and perhaps materially – by the end of 2020 has helped juice the rally in longer-term debt. But patience – the central bank’s mantra – is almost definitionally incompatible with a proactively accommodative posture.
Even Minneapolis Fed President Neel Kashkari – arguably the most dovish member of the FOMC – does not think a so-called “insurance” rate cut is appropriate. A more hawkish member – Kansas City chief Esther George – thinks a rate reduction could fuel financial excesses.
If the market switched to betting the Fed will stay on hold this year, and if 10-year yields moved in lock-step with fed funds futures, then 10-year Treasuries would be north of 2.60% and trading closer to the 2019 highs than the trough.
(Bloomberg) Walmart Rallies on Plan to Pass on Cost of Tariffs to Consumers
Comparable sales for Walmart stores in the U.S. climbed 3.4% in the first quarter, its best for the period in nine years. Sales of groceries — Walmart’s biggest business — fueled the increase, and a later-than-usual U.S. flu season boosted health and wellness products. The shares rose as much as 4.1% Thursday in New York, the biggest intraday gain in almost three months.
Walmart’s response to potential higher levies will likely set the tone for other discount retailers, and its decisions on whether to pass along or absorb the additional costs will have ripple effects on American consumers. In its favor, Walmart’s clout with suppliers gives it more room to maneuver, and much of its food comes from U.S. sources, easing the impact.
“We will do everything we can to keep prices low, but increased tariffs lead to increased prices,” Chief Financial Officer Brett Biggs said in a Thursday morning interview. “It’s very item- and category-specific. There are some places where as we get tariffs, we will take prices up.” Finding alternative manufacturers “is one of a number of actions that our merchants are considering.”
Walmart’s response to potential higher levies will likely set the tone for other discount retailers, and its decisions on whether to pass along or absorb the additional costs will have ripple effects on American consumers. In its favor, Walmart’s clout with suppliers gives it more room to maneuver, and much of its food comes from U.S. sources, easing the impact.
“We will do everything we can to keep prices low, but increased tariffs lead to increased prices,” Chief Financial Officer Brett Biggs said in a Thursday morning interview. “It’s very item- and category-specific. There are some places where as we get tariffs, we will take prices up.” Finding alternative manufacturers “is one of a number of actions that our merchants are considering.”
Amid a deluge of new issue supply and a weaker macroeconomic backdrop, we can finally say that the investment grade credit markets experienced a week of notable spread widening. The spread on the corporate index closed Thursday at 116, 4 basis points wider on the week and 7 basis points off the lows from mid-April. China trade headlines have dominated the tape this week which has led to volatility in the equity markets that has subsequently spilled over into the credit markets. The impact to corporate credit has been relatively muted thus far but we would welcome short term bouts of volatility in our market as that has the potential to allow us to be more opportunistic in our purchases for the portfolios we manage.
$45.65bln of new corporate debt was issued this week led by Bristol-Myers and IBM. On Tuesday, BMY printed $19bln in new bonds which at the time was the largest deal of 2019 and the 10th largest of all time. BMY was bested by IBM a mere 24 hours later as Big Blue printed $20bln in new debt to fund its purchase of Red Hat, tied for the 7th largest bond deal of all time. It is worth noting that, although CAM is a regular participant in the new issue market, we did not see value in either of these deals so we remained on the sidelines awaiting better opportunities. $51.9bln of new corporate debt has been priced in the month of May and the year-to-date tally of new issuance is up to $439bln according to data compiled by Bloomberg.
According to Wells Fargo, IG fund flows during the week of May 2-May 8 were +$3.3bln. This brings YTD IG fund flows to +$103.614bln. 2019 flows to this juncture are up 4% relative to 2018.
Bloomberg) IBM Sells $20 Billion of Bonds as Market Defies Trade Drag
International Business Machines Corp. sold $20 billion of bonds, propelling the corporate-debt market to its busiest week in at least eight months despite turbulence across asset classes worldwide.
The senior unsecured bonds will help fund the computer-services giant’s acquisition of Red Hat Inc. The longest portion of the offering, a 30-year security, will yield 1.45 percentage points more than Treasuries, after initial talk of around 1.55 percentage points, according to a person with knowledge of the matter, who asked not to be identified as the details are private.
The order book for IBM’s eight-part bond sale was just shy of $40 billion, suggesting some investor indigestion following Tuesday’s offering from Bristol-Myers Squibb Co. The drugmaker managed to sell $19 billion of bonds, one of the biggest sales of the year.
The U.S. investment-grade corporate bond market reached record highs on Tuesday, shrugging off the trade war fears that have weighed on stocks and oilthis week. High-grade issuance this week could top $40 billion, the most since September, according to data compiled by Bloomberg. High-yield issuers are also taking advantage of the frenzy — they collectively had their busiest day in three months.
More big bond offerings are coming. T-Mobile US Inc. and Fidelity National Information Services Inc. are expected to issue debt in the coming weeks to fund their respective acquisitions.
Companies are tapping the bond market to finance acquisitions after having shied away from that kind of issuance for much of the year. Just over $60 billion of investment-grade corporate debt was sold for that purpose in the first four months of the year, including about $2 billion in April, according to data compiled by Bloomberg. That’s out of $445.4 billion of total issuance over that period. Companies instead focused on selling bonds to refinance maturing securities and fund capital expenditure, among other corporate uses.
Bond-sale volume linked to acquisitions is increasing now in part because borrowing has grown even cheaper: the average high-grade company bond yielded 3.6% on Tuesday, according to Bloomberg Barclays index data, close to its lowest level since early 2018. The debt has gained 5.9% this year.
(Bloomberg) Boeing Sends 737 Max to Brand Rehab to Avoid Fate of Ford Pinto
Boeing Co.’s 737 Max is about to join the list of brands trying to come back from ignominy.
Analysts are digging into decades-old safety scares for clues to the future of the jetliner — and Boeing’s finances. There’s the Chevrolet Corvair rollovers that launched Ralph Nader as a consumer advocate in the 1960s, gas-tank explosions that sank Ford Motor Co.’s Pinto in the 1970s, and the Tylenol poisonings of 1982 that spurred tamper-proof packaging.
But there’s little precedent for the tangle of safety, regulatory and financial issues buffeting a workhorse jet that’s vital to sustaining the surge in global air travel. After two crashes of the aircraft model in five months and a grounding that’s nearing the two-month mark, some nervous passengers are vowing to avoid the Max. Boeing has added to the mess by not fully explaining the apparent flaws in the best-selling jet in company history.
Longtime Boeing watcher Nick Cunningham said he’s starting to wonder if “this has become too serious and too protracted for the Max to escape unscathed.” The accidents in Indonesia and Ethiopia killed 346 people. Nader’s own grand niece was among the victims.
The longer the crisis drags on, the greater the risk that the cumulative effect “will have acted to permanently lock it into people’s memories,” said Cunningham, founding partner at Agency Partners.
Boeing is finalizing an update to software linked to both crashes, which it will submit to the Federal Aviation Administration in a crucial step toward getting the plane back in the air. A May 23 summit of global regulators “may lay out a path towards certifying fixes and removing the grounding,” Morgan Stanley analyst Rajeev Lalwani said in a note Thursday.
Rebuilding consumer confidence is an urgent priority, as the Chicago-based company works with airlines to prepare resuming flights of the 737 model over the next few months. Boeing must also win over pilots, flight attendants and fractious regulators.
(Bloomberg) Chevron’s Mr. Discipline Sizes Up Costs as Anadarko Bid Ends
Chevron Corp. Chief Executive Officer Mike Wirth’s decision to abandon his $33 billion offer for Anadarko Petroleum Corp. bolsters his reputation as one of the oil industry’s consummate financial disciplinarians.
Anadarko was looking for Chevron to beat or at least match Occidental Petroleum Corp.’s $38 billion proposal, people familiar with the matter said Wednesday. But Wirth, whose deputies already had held integration meetings with counterparts at Anadarko, declined to escalate the bidding war and bowed out on Thursday.
“Make no mistake about it, we had the financial capacity to easily outbid Occidental,” Wirth said in an interview. “But an increased offer would have eroded value to our shareholders and would have diminished returns on our capital. We’re serious about being disciplined.”
The decision to cede Anadarko to a rival one-fifth of its size would have been unthinkable even five years ago, in the heady days of $100 a barrel oil when the world’s largest energy companies were focused on growth at almost any cost. But the crude price collapse, ascendance of of shale and a recognition that big deals often destroy shareholder value has changed Big Oil’s mindset.
The investment grade credit market traded sideways this week as the OAS on the corporate index looks to finish relatively unchanged. Spreads continue to remain near their tightest levels of 2019 which has been the case since mid-April. It was a busy week for earnings and it was feast or famine for some large-cap firms. Companies like Microsoft and Amazon produced some exceptional results while on the other hand Intel and 3M had lackluster earnings prints. On the Treasury front, rates are lower by 3-5 basis points across the curve on the back of an economic release that showed inflation measures are slowing.
It was an extremely quiet week for corporate issuance as companies brought just $5.65bln of new corporate bonds. Earnings blackout periods will likely continue to have an impact on issuance for the next several weeks. $50.8bln of new corporate debt has been priced in the month of April and the year-to-date tally of new issuance is up to $371bln according to data compiled by Bloomberg.
According to Wells Fargo, IG fund flows during the week of April 18-April 24 were +$6.7bln, which was the second largest weekly inflow thus far in 2019. This brings YTD IG fund flows to +$97.6bln. 2019 flows to this juncture are up 3.8% relative to 2018.
(Bloomberg) A 48-Hour Reporting Delay Could Be Coming for Corporate Debt
The Financial Industry Regulatory Authority will likely test the market impact of delaying the disclosure of large corporate bond trades after some of the biggest investors argued that such a move would improve liquidity.
Finra last week proposed running a pilot program that would give traders 48 hours before having to reveal their so-called block trades to other investors. The effort would allow the industry-funded brokerage regulator, which is overseen by the U.S. Securities and Exchange Commission, to evaluate how delayed transparency might affect corporate bond trading.
Current rules require that block trades be reported within 15 minutes. Brokers and investment firms such as BlackRock Inc. and Pacific Investment Management Co. have long said that such rapid disclosure can make it harder for a dealer to offload securities it’s bought, because market participants know exactly what was bought and at what price.
The idea for the pilot was suggested by a group of industry executives that advises the SEC. The Securities Industry and Financial Markets Association, Wall Street’s biggest trade group, has expressed support for the proposed test as did JPMorgan Chase & Co. and Eaton Vance, according to Finra. At the same time, the regulator said that two market makers for exchange-traded funds have expressed concern that the changes would reduce price transparency.
(Bloomberg) Wall Street Said to Accelerate Shake-Up in Market for New Bonds
Wall Street is moving closer to modernizing the clubby $2 trillion market for new corporate bond issues while seeking to retain control of a lucrative business that’s being eyed by the tech sector.
A group of banks led by Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co., has set up a company and appointed a chief executive officer to develop an electronic system for investors to request allocations of new debt, according to people familiar with the matter.
Other banking heavyweights including Barclays Plc, BNP Paribas SA, Deutsche Bank AG, Goldman Sachs Group Inc. and Wells Fargo & Co. have also joined the founders in backing the platform that was originally conceived more than a year ago, the people said, asking not to be identified because it isn’t public.
Bloomberg talked to 10 people familiar with the initiative. While many of its details are yet to be finalized, Bloomberg reported a year ago the banks plan to focus initially on U.S. investment-grade bonds.
The new system, dubbed Project Mars, aims to modernize the process of buying new corporate bonds, streamlining communication in a market that still relies on phone calls, instant messaging and emails to handle billions of dollars in orders from investors.
Investors have pushed banks for years to streamline the market and make it more transparent amid mounting frustration at current practice where they often over-order to secure a quota of bonds that’s close to what they want. Bond allocation has become a high-stakes game, as demonstrated by Saudi Aramco’s recent $12 billion deal which saw investors place orders for more than $100 billion.
(Bloomberg) Ford Shares Surge After Q1 Earnings Beat as U.S. Sales Offset Global Weakness
Ford Motor Co. shares were traded sharply higher Friday after the carmarker posted stronger-than-expected first quarter earnings thanks to a surge in U.S. demand for its iconic pick-up trucks that offset weakening international demand.
Ford said earnings for the three months ending in March rose nearly 52% from the same period last year to a forecast-beating 44 cents a share even as total revenues edged 3.9% lower to $40.34 billion as key markets in China continue to weaken.
S. sales, however, held steady at $25.4 billion. with healthy demand for trucks and SUVs in the company’s home market providing $2.2 billion of its overall $2.4 billion in operating earnings for the quarter.
(Bloomberg) U.S. Growth of 3.2% Tops Forecasts on Trade, Inventory Boost
S. economic growth accelerated by more than expected in the first quarter on a big boost from inventories and trade that offset slowdowns in consumer and business spending, bolstering hopes that growth is stabilizing after its recent soft patch.
Gross domestic product expanded at a 3.2 percent annualized rate in the January-March period, according to Commerce Department data Friday that topped all forecasts in a Bloomberg survey calling for 2.3 percent growth. That followed a 2.2 percent advance in the prior three months.
But underlying demand was weaker than the headline number indicated. Consumer spending, the biggest part of the economy, rose a slightly-above-forecast 1.2 percent, while business investment cooled. A Federal Reserve-preferred inflation measure, the personal consumption expenditures price index excluding food and energy, slowed to 1.3 percent, well below policy makers’ 2 percent objective.
After being rebuffed several times, Occidental Petroleum Corp. on Wednesday made public a $38 billion offer to buy Anadarko Petroleum Corp., seeking to break up a proposed takeover by Chevron Corp. The $76 per share cash-and-stock bid for The Woodlands, Texas-based oil and natural gas producer is 20 percent more than Chevron’s $33 billion April 12 agreement.
For Occidental, which has a market value of about $46 billion, the acquisition would be its largest ever and the biggest purchase of an oil producer anywhere in at least four years. It would pull together two second-tier oil and natural gas producers, as opposed to Chevron’s bid to create another “ultramajor” to rival Exxon Mobil Corp. It would require Anadarko to pay a $1 billion breakup fee to Chevron.
In an email, Chevron spokesman Kent Robertson said the company was “confident the transaction agreed to by Chevron and Anadarko will be completed.”
A tie-up would help Occidental maintain its leading position in the Permian Basin of West Texas and New Mexico, where it currently faces being overtaken by Chevron, which has ambitious growth plans for the region. The Permian is the world’s fast-growing oil major patch and has helped to turn the U.S. into a net exporter, also making it a bigger producer than Saudi Arabia.
Chief Executive Officer Vicki Hollub said in a Bloomberg Television interview that the offer is the same it made to Anadarko in January 2018. The company has also made three bids since late March, she said Wednesday in a letter to Anadarko’s board of directors. Occidental said it has completed its due diligence on the deal and has financing lined up with Bank of America Merrill Lynch and Citigroup Inc.
The investment grade credit market continues to benefit from the euphoria of risk-on sentiment that is flooding the capital markets. The OAS on the index closed Thursday at its tightest level of the year. Segmenting the index out by quality, both the A-rated portion of the index and the BBB-rated portion are now trading at year-to-date tights. The market also feels quite strong as we go to print on Friday morning and it looks likely that the corporate bond index will close the week even tighter still. On the Treasury front, rates are higher across the curve, with the 5yr Treasury up 6 basis points over the past week and the 10yr Treasury up 5 basis points.
Corporate issuance was somewhat muted as borrowers brought just $10.15bln of new debt during the week. Corporate issuance is likely to remain light in the weeks to come as many companies are now in earnings blackout periods. The big story of the week on the new-issuance front was non-corporate borrower Saudi Arabian Oil Co, which priced $12bln of new debt across 5 tranches. The Saudi bonds were soaked up by yield chasers across the globe on no other analysis other than it was “cheap for the rating.” According to Bloomberg, the order book for the new issue was allegedly in excess of $100bln which is quite strong relative to the $12bln size of the deal. However, all 5 tranches of debt immediately traded wider on the break and all remain wider on the bid side as we go to print. The 10yr tranche in particular is sucking wind, and is currently bid at +120 in the street versus its new issue pricing level of +105. This leads us to believe that demand for this deal may have been overstated, possibly by an order of magnitude. $26.2bln of new corporate debt has been priced in the month of April and the year-to-date tally of new issuance is up to $346bln according to data compiled by Bloomberg.
According to Wells Fargo, IG fund flows during the week of April 4-April 10 were +$8.7bln. This brings YTD IG fund flows to +$81bln. 2019 flows to this juncture are up 2.6% relative to 2018.
The performance of investment grade credit during the opening quarter of the year was in stark contrast to the final quarter of 2018, as risk assets of all stripes performed well during the first quarter. The spread on the Bloomberg Barclays US Corporate Index finished the quarter 34 basis points tighter, after opening the year at a spread of 153 and closing the quarter at a spread of 119. The one-way spread performance of investment grade credit was so pronounced that at one point in the quarter there was a 22 trading day streak where the market failed to close wider from the previous day.i This was a remarkable feat considering that there were just 61 trading days during the quarter. The 10yr Treasury opened the year at 2.68% and closed as high as 2.79% on January 18th, but it finished the quarter substantially lower, at 2.41%. Tighter spreads and lower rates yielded strong performance for investment grade credit and the Bloomberg Barclays US Corporate Index posted a total return of +5.14%. This compares to CAM’s gross total return of +4.95% for the Investment Grade Strategy.
What a Difference Three Months Makes
When the Federal Reserve issued its December FOMC statement the consensus takeaway by the investor community was an expectation of two rate hikes in 2019 with one additional rate hike thereafter, in 2020 or 2021. In any case, the prevailing thought was that we were nearing the end of this tightening cycle with a conclusion to occur over the next two or three years. The Fed then took the market by surprise in late January, with language that was more conservative than expected as FOMC commentary signaled that they were less committed to raising the Federal Funds Rate in 2019. It was at this point that the market perception shifted – with most investors expecting just one rate hike in the latter half of 2019. The March FOMC statement was yet another eyeopener for Mr. Market, with language even more dovish than the decidedly dovish expectations. The consensus view is now murkier than ever. Some market prognosticators are pricing in rate cuts as soon as 2019; but the more conservative view is that barring a material pickup in global growth or domestic inflation we may not see another increase in the federal funds rate for 6-12 months, if at all in this cycle. It is entirely possible that the current tightening cycle has reached its conclusion and that lower rates could be here to stay.
In the days following the March 20th FOMC release, the 10yr Treasury rallied sharply and there were two days during the week of March 25th where the 90-day Treasury bill closed with a slightly higher yield than the 10yr Treasury. This was the first time that this portion of the yield curve has been inverted since August of 2007. Note that this inversion was very brief in nature and as we go to print at the end of the day on April 1st, the 3m/10yr spread is no longer inverted and is now positive sloping at +17 basis points. That is not to say that this portion of the curve will not invert again, because Treasury rates and curves are dynamic in nature and ever changing.
What Has Happened to Corporate Credit Curves?
This is a common question in the conversations we have had with our investors in recent weeks. Corporate markets are entirely different from Treasury markets and behave much more rationally. The defining characteristic of corporate credit curves is that they nearly always have a positive slope. History shows that corporate credit curves typically steepen as Treasury curves get flatter. There are fleeting moments from time to time where corporate credit curves become slightly inverted but these instances are brief in nature and are quickly erased as market participants are quick to take advantage of these opportunities. For example, there may be a motivated seller of Apple 2026 bonds at a level that offers slightly more yield than Apple 2027 bonds. This has nothing to do with dislocation in the Apple credit curve and everything to do with the fact that there is an extremely motivated seller of the bond that is slightly shorter in maturity. Once that seller moves their position, the curve will return to normalcy and you could once again expect to obtain more yield for the purchase of the 2027 bond than you would for the 2026 bond. The following graphic illustrates current 5/10yr corporate credit curves for two widely traded investment grade companies, one A-rated and one BBB-rated. As you can see, corporate credit curves are much steeper than the spread between the 5 and 10yr Treasury.
The Bottom Line
The takeaway from this exercise is that investors will always be afforded extra compensation by extending out the corporate credit curve. At Cincinnati Asset Management, one of the key tenets of our Investment Grade Strategy is that we believe that it is nearly impossible to accurately predict the direction of interest rates over long time horizons. However, throughout economic cycles, we have observed that the 5/10 portion of the curve is usually the sweet spot for investors. Consequently, the vast majority of our client portfolios are positioned from 5 to 10 years to maturity. We will occasionally hold some positions that are shorter than 5 years but we almost never purchase securities longer than 10 years. Further, while an investor can earn more compensation for credit risk by extending out to 30yrs, more often than not this strategy entails excessive duration risk relative to the compensation afforded at the 10yr portion of the curve. Our strategy allows us to mitigate interest rate risk through our intermediate positioning and allows us to focus on managing credit risk through close study and fundamental analysis of the individual companies that populate our portfolios.
Where in the World is the Yield?
The value of negative yielding global debt hit a multiyear low in October of 2018 but it has exploded since, topping $10 trillion as the sun set on the first quarter, the highest level since September 2017.ii
The growth in negative yielding debt has, in some cases prompted foreign investors to pile into the U.S. corporate debt market. A measure of overseas buying in 2019 has more than doubled from a year earlier according to Bank of America Corp.iii Japanese institutions are among the biggest of the foreign investors and the Japanese fiscal year started on April 1, which could lead to even more buying interest in U.S. corporates according to Bank of America. According to data compiled by the Federal Reserve as of the end of 2018, Non-U.S. investors held 28% of outstanding U.S. IG corporate bonds.iv What does this all mean for the U.S. corporate bond market? First, it is safe to assume that foreign demand certainly played a role in the spread tightening that the investment grade credit markets have experienced year to date. Second, although U.S. rates may seem low, when viewed through the lens of global markets, they are actually quite attractive on a relative basis. As long as these relationships exist then there will be continued foreign interest in the U.S. credit markets.
Although our Investment Grade Strategy trailed the index in the first quarter, we are pleased with the conservative positioning of our portfolio. The modest underperformance can largely be explained by our significant underweight in lower quality BBB-rated credit relative to the index. We do not have a crystal ball, but are reasonably confident that we are in the later stages of the credit cycle so we continue to place vigilance at the forefront when it comes to risk management. Please know that we take the responsibility of managing your money very seriously and we thank you for your continued interest and support.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness. See Accompanying Endnotes
i Bloomberg Barclays US Corporate Total Return Value rounded to the nearest hundredth from the close on January 3rd, to the close on February 7th
ii Bloomberg, March 25, 2019, “The $10 Trillion Pool of Negative Debt is Late-Cycle Reckoning”
iii Bloomberg, March 22, 2019, “U.S. Corporate Debt Is on Fire This Year Thanks to Japan”
iv CreditSights, March 8, 2019, “US IG Chart of the Day: Who’s Got the Bonds?”
