UBS Sees Speculative Grade Credit Bubble

UBS strategist Matthew Mish simply asks ‘Is there a US corporate credit bubble?’, he then proceeds to look at the bullish and bearish cases.

The bullish case argues that fundamentals remain healthy and profits will not not decline materially in the intermediate term.

“Corporate fundamentals are deteriorating incrementally and from a relatively healthy position. US corporate debt to profits, assets and net worth do not appear extreme. While US corporate profit margins are elevated, they will not decline materially in the intermediate term – particularly if inflation remains sluggish and the Fed stands pat. Low government bond yields reduce the cost of interest payments, limiting refinancing risks and renewing the bid for yield.”

Meanwhile, the bearish case shows that issuance is way down and commodity-related issues will push default rates sharply higher.  Further, leverage is at late 1990s levels.

Credit fundamentals, particularly in US speculative grade, are in a more dire state. HY issuance is down 53% in 2016, indicative of a substantial tightening in credit conditions. Commodity-related stress will increase default rates to 5.5%, and the broader universe is more leveraged than in the late 1990s. This leaves firms more vulnerable to peaking profit margins, rising interest costs, tighter capital markets and a slowdown in US growth. Market illiquidity and the zero bound create significant uncertainty around valuations in a downside scenario.

Overall, Mish believes there is a bubble in speculative grade credit.  He said easy money from central banks limited credit losses in the last cycle, which kept many ‘zombie’ firms afloat.  In addition, QE triggered substantial inflows into credit funds, igniting a material reach for yield.  He said this translated into “elevated competition, easing credit standards, and massive issuance.”

Commenting on what is priced in, he said given the recent rally in HY bonds and leveraged loans they believe market implied pricing is largely consistent with the bullish view.

Texas Oil Industry Continues to Be Gutted

Sterne Agee CRT analyst, Tim Rezvan, spent much of last week in Houston and Dallas meeting with companies and clients in the E&P sector.  Takeaways were grim for the companies in the sector but cutbacks could be helpful to the underlying commodity price. That said, the analyst said they expect WTI and Brent to retreat back to $30/bbl in the near term.  They remain cautious.

Key takeaways from the trip are as follows:

1) all companies/investors the firm spoke with expect to see a higher oil by y/e 2016, and a subsequently higher price by y/e 2017, given the sharp decrease in capital spending since late ’14,

2) more operators are citing a shortage of pressure-pumping capacity across the industry as a real concern in ’17 that may exacerbate a future rally in oil prices, and

3) operators continue to see efficiencies and lower well costs driving down cost structures.

On this, the analyst said:

“With that backdrop, we expect an aimless, range-bound market for E&P equities to persist through 1Q earnings. Greenshoots for a rally are emerging, but near-term data points reinforce our caution.”

The analyst believes hope is (still) not a near-term investment thesis and they have little optimism we will see a materially bullish event emerge out of the Doha meetings planned for April 17.  They believe we could see WTI and Brent retreat back to $30/b in the near term.  They would argue this final capitulation would force U.S. producers to adhere to their lower spending/production forecasts, and could an important driver that brings global oil markets back into equilibrium in 2017. This dynamic reinforces their current WTI price deck of $40/b in ’16 and $49/b in ’17.

They believe there will be a time later this year when adding oil exposure will be prudent for long-only investors, but they do not believe that moment is today.

Is Weak IPO Market the Canary in the Coal Mine?

If the stock market is so healthy then why is the IPO market absolutely dead?  This is a question the WSJ addresses with IPOs off to their slowest start since the first quarter of 2009, in terms of deals and dollars raised.

“Either the IPO market is going to pick up, or the stock market is going to pull back, but it’s hard to envision both conditions peacefully coexisting,” said Jack Ablin, chief investment officer at BMO Private Bank.

In Q1 2016, there were only nine deals, raising a combined $1.2 billion.  This was the smallest since two IPOs combined for $890 million in the first quarter of 2009.

Off the nine deals, 3 are blank-check companies.  5 of the other 6 are higher, with Editas Medicine (NASDAQ: EDIT) leading the way with a 119% gain from its IPO price.

Gold Has Best Quarter in 25 Years

Gold is set to have its biggest quarterly advance since September 1990, Bloomberg noted.  Thanks Ms. Yellen!

From Bloomberg:

Gold headed for the biggest quarterly advance since September 1990 as demand for haven assets surged to make the metal this year’s best performing major commodity.

Bullion for immediate delivery rose 0.5 percent to $1,230.86 an ounce by 3:22 p.m. in Singapore, according to Bloomberg generic pricing. The metal is up 16 percent since the start of January in the first quarterly gain since June 2014.

Gold rallied this year as it cemented its status as a store of value amid financial market turbulence and concern about the global economy, which led to speculation that the Federal Reserve would pause on tightening monetary policy in the U.S. A gauge of the U.S. currency headed for the biggest quarterly loss since 2010 after Fed Chair Janet Yellen said Tuesday the central bank will act “cautiously” as it looks to withdraw stimulus. Investor holdings in exchange-traded products have expanded by about 300 metric tons this quarter, the most since March 2009.

“The dovish remarks by Yellen earlier this week which reinforced the Fed’s stance to proceed gradually and cautiously with rate hikes this year have weighed on the U.S. dollar index, which is a positive for gold,” Vyanne Lai, an economist at National Australia Bank Ltd., said by e-mail. “Investment demand for gold appears to be holding up.”

Tame Wage Pressure Suggests Inflation Pickup Only Temporary

Data in February showed core PCE inflation is up 1.7%, which would be just below the Fed’s target of 2%.  However, Deutsche Bank economist Joseph Lavorgna believes that the recent pickup in core inflation is temporary because it has not occurred alongside any noticeable increase in wage pressures.

He highlights that average hourly earnings, the employment cost index and worker compensation have all been trending sideways.

Continue reading “Tame Wage Pressure Suggests Inflation Pickup Only Temporary”

Yellen Gives Bulls Some Juice

Can you spot in the chart below where Fed Chairman Janet Yellen made dovish comments?

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In her speech today, Yellen indicated the Fed should proceed “cautiously” as it looks to raise interest rates again.

“Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy. This caution is especially warranted because, with the federal funds rate so low, the FOMC’s ability to use conventional monetary policy to respond to economic disturbances is asymmetric. If economic conditions were to strengthen considerably more than currently expected, the FOMC could readily raise its target range for the federal funds rate to stabilize the economy. By contrast, if the expansion was to falter or if inflation was to remain stubbornly low, the FOMC would be able to provide only a modest degree of additional stimulus by cutting the federal funds rate back to near zero.”

Yellen also dismissed claims the Fed is out of bullets, saying even if rates return to zero the Fed has a ‘considerable scope’ to provide additional accommodation.

“One must be careful, however, not to overstate the asymmetries affecting monetary policy at the moment. Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy–specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities. While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed.”