Month: April 2016

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.

New Jersey Freaks as David Tepper Packs Bags to Florida

Hedge fund titan David Tepper is sick and tired of paying nosebleed-high income taxes in New Jersey and has now made Florida the permanent home for his hedge fund and himself.  Now state revenue officials in high income tax states are freaking out.

From Bloomberg:

Tepper, 58, registered to vote in Florida in October, listing a Miami Beach condominium as his permanent address, and in December filed a court document declaring that he is now a resident of the state. On Jan. 1, he relocated his Appaloosa Management from New Jersey to Florida, which is free of personal-income and estate taxes.

His move has state revenue officials on alert.

“We may be facing an unusual degree of income-tax forecast risk,” Frank Haines, budget and finance officer with the Office of Legislative Services told a Senate committee Tuesday in Trenton.

Some 40% of New Jersey’s revenue comes from personal income taxes so it’s a big deal.  Top earners in the state can pay up to 9%.

With zero personal income tax in Florida it is no wonder Mr. Tepper and other hedge funds are looking to set-up shop in Florida and other tax-friendly states, both professionally and and personally.

There will likely be no end to the exodus of capital from highly-taxed states.

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.