Author Archives: CFAMNEB

Call Me Maybe

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Investment grade credit had a good month – the corporate benchmark was up almost 1.5%, and excess returns were positive by 83 basis points. Interest rates and bond spreads tend to be negatively correlated, so we don’t normally expect a month where both help performance. For October, though, fading expectations for a Fed taper really helped interest rates and riskier assets alike. Financials outperformed on an excess returns basis, as they have all year, and the longer duration the better. Most of the positive performance this month came in the few days after Congress’s debt ceiling deal. Spreads are now more than one standard deviation below their mean for the past 12 months. I can’t say that means they’re overvalued – the range of spreads is getting pretty narrow, and one standard deviation over the past year is just 5 basis points.

What I can say is that we think risk-taking probably ramps up a bit. As mentioned last week, we are entering that phase of the credit cycle. From a credit standpoint, TMT continues to look like the hot spot. (TMT refers to Telecom / Media / Tech. I think that might be a credit-only moniker). Whether it’s a rumor about an AT&T bid for Vodafone or a buyout of Time Warner Cable, the sector continues to come under pressure. Media spreads are wider year-to-date by about 30 basis points, making it one of the few sectors with negative excess returns for the year. Some of the transactions being contemplated actually do seem a little crazy, but it sure feels like there are a few connections just waiting to happen.

Issuers came back to the market this week, bringing about $23 billion in supply. Coca-cola was the biggest, with a $5 billion, 5 tranche deal. KO is one of the few AA-rated issuers left in the market, and their deals are generally well received. Not to be outdone, AA-rated Procter & Gamble brought a $2 billion deal the next day, also well received. On the other end of the spectrum, Altria Group (rated Baa1/BBB) was in the market with $3.2 billion of 10s and 30s.  Next week, we are expecting more of the same, with probably $25-30 billion of supply expected.  It looks like we are setting up for a pretty ordinary month. Maybe.

Thinking Ahead

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One of the challenges of living in the Upper Midwest is that you have to prepare for the Holidays now before it gets too cold. As we say in our household, “Easter is the time of year when can take down the outside Christmas lights you put up after Halloween because the extension cords were frozen solid to the ground since Thanksgiving.” Therefore, we in the Tundra pride ourselves on thinking ahead. We were wondering if we need to think ahead about Affordable Care Act impacts, or if it is too early.

Many health care consumers are having their coverage dropped from their insurance provider (see link below). Much ink has been spilled discussing how that may impact health care companies. We also wonder if this will impact the broader economy, and if so when and do we need to prepare now as investors?

Our gut feel is that it will have less of an impact on the truly affluent in this country as many can pay out of pocket or find alternative sources of care worldwide. We also wonder if little will change with the less affluent. Yes many more will have affordable insurance, but we also do not know what the final deductible and co-payments might be until we get more data on the demographic characteristics of those that signed up. That leaves our large middle class. If premiums, deductibles and co-pays rise for a good percentage of middle-class Americans (e.g. those without existing conditions), what will that mean for disposable income? Will increasing health care costs crowd out consumer spending and will it impact other sectors?

Part of us says that it is too early to make any investment decision, especially since those who work for larger corporations will not feel the impact until 2015 since larger companies received a one year extension under the Affordable Care Act. But still a sizable subsector of the middle class could feel the impact by January, and others who are not affected now may see the impact higher costs have on their neighbors and act accordingly beforehand. What do you think?


 

 

Supporting links:

http://www.kaiserhealthnews.org/Stories/2013/October/21/cancellation-notices-health-insurance.aspx

http://www.bloomberg.com/news/2013-07-02/health-law-employer-mandate-said-to-be-delayed-to-2015.html

A Horse with No Name

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It looks like we will end this week with negative excess returns – just barely, as spreads have moved around in a fairly directionless market. Part of the issue, from our perspective, is that the current credit cycle is getting a little long in the tooth. Credit regularly goes through a boom and bust cycle. Corporate debt levels expand (slowly at first, then rapidly as companies face an earnings shock) and contract, while credit spreads tend to follow this cycle. Right now, revenue growth at most companies is lagging earnings growth, and that is precisely the time management teams turn to higher leverage to boost shareholder returns — which will eventually push credit spreads wider. But spreads can move sideways for quite a while, generating solid excess returns. The challenge for credit investors right now is to figure out which horse they’re riding.

It has continued to be a bit of a desert with respect to new issue. We had another light week, with just about $12 billion in supply. Following earnings releases, a few banks came to market – Wells Fargo brought $3.5 billion of 5s and 30s, Citigroup did $2 billion of a senior unsecured 10 year, while Bank of Nova Scotia and Suntrust were both in the market with 5 year deals. The Wells Fargo 5 year was probably the star of the week – the deal was well oversubscribed, priced at a spread of 85bps to Treasuries, and is trading about 10 tighter. The Citigroup deal is the laggard for the week, trading a few basis points wider. Continue reading →

Mall Rats Abandoning Ship

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We’re a guy, so we only go to the mall when one of two things occur:

1)      A kid’s birthday party at the Mall of America

2)      When we need underwear

However, we need to focus on consumer spending for investment purposes despite our lack of fashion élan. One thing we have noticed is the number of retailing companies that are mentioning weak traffic and heavy discounting. It seemed to start with the teen retailers, but the trend seems to be more systemic than we thought. Even some of the better performing names in the group and even certain ecommerce companies are discussing weakness. That got our attention.

The question we have is why is this happening? One argument is the government shutdown. Perhaps, but some retailers, especially the teen retailers, were seeing less traffic/conversion well before the shutdown. Could it be the sequester causing the slowdown? We would like to see results out of broader areas of the economy this earnings season, such as manufacturing, before we lay credence to that theory. Could it be employers are adjusting hours in advance of the Affordable Care Act? We have seen some companies such as Forever 21 adjusting hours downward to limit the number of full time workers. Others such as Walgreens are moving their employees to private healthcare exchanges, and some other companies are doing the same for their retirees. Could it be tax increases earlier in the year now affecting the consumer? Is it the consumer trying to tell us something about their future spending and job prospects that are not showing up in the data yet? Could it be a combination of all of the above? Or are there a lot of people like us that have plenty of underwear and don’t need to go to the mall? What do you think?

Supporting links:

http://money.msn.com/now/post–forever-21-caught-in-obamacare-controversy

http://www.reuters.com/article/2013/09/18/us-healthcare-exchanges-private-idUSBRE98H03120130918

Something’s Got to Give

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And so, after weeks of bluster around the budget / debt ceiling impasse, something did finally give. No political comments here, but we seem to be right back where we started, with just a little breathing room. Nevertheless, with the possibility of an imminent U.S. default off the table, risk markets reacted favorably, and Credit was among them – the index was tighter by 4-5 basis points. This doesn’t seem fair, in some ways. Equities at least traded lower during the uncertainty, before rebounding to new highs. But cash credit spreads have been tightening all along. Lack of supply, continued strong demand – it feels like a very technical market to me right now, but spreads just keep grinding in. Continue reading →