Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$5.3 billion and year to date flows stand at -$22.9 billion. New issuance for the week was zero and year to date issuance is at $71.5 billion.
(Bloomberg) High Yield Market Highlights
U.S. junk bonds may pare losses Friday with stock futures higher and oil extending a recovery. But the asset class has lost the most in any month so far since 2008, and investors pulled billions of dollars of cash from funds.
Yet the junk-bond index has posted losses for 11 straight sessions, with 2.63% on Thursday alone. The asset class has lost 17.6% year-to-date and 16.46% in March, the biggest monthly loss since 2008
High-yield spreads widened 72bps Thursday to 976bps. Single-B spreads widened 78bps to 990bps. That’s very close to the 1,000bps that’s typically considered distressed
In less than two weeks, the amount of distressed debt in the U.S. has doubled to a half-trillion dollars as the collapse of oil prices and the fallout from the coronavirus shutters entire industries.
Junk-bond yields jumped 63bps to close at 10.75%, the highest since September 2009
Energy-bond yields surged to a new 20-year high of 23.69%, with the index losing more than 37% this month
High-yield bonds with more than $1.37b outstanding are trading above upcoming call prices, making it attractive for issuers to redeem the securities in the next three months. But that’s down 70% from the prior week, and the primary market hasn’t seen a deal price since March 4
Banks that agreed to help private equity firms and highly leveraged companies fund recent acquisitions may have to come up with billions of dollars of their own cash
to finance the deals if the market for risky debt remains shut.
Underwriters across Wall Street have committed to providing more than $30 billion to junk-rated companies by mid-year, according to data compiled by Bloomberg and people with knowledge of the matter who asked not to be identified because not authorized to speak publicly.
But with the markets for leveraged loans and high-yield bonds virtually shut since the Covid-19 pandemic triggered fears of a global recession, the banks now face the prospect that they might not be able to offload the risk before the takeovers are scheduled to close.
The exposure is a small fraction of the commitments they held heading into the 2008 financial crisis. Still, it could force banks to take losses or tie up capital for months just as
dozens of companies are drawing credit lines or seeking fresh financing to cope with the coronavirus fallout.
The deals run the gamut of sectors and geographies, ranging from an $11 billion financing for the leveraged buyout of ThyssenKrupp’s elevator unit in Europe to a $500 million debt deal for Culligan’s acquisition of water-filtration company AquaVenture.
Representatives for lead arrangers including Morgan Stanley, JPMorgan Chase & Co., Deutsche Bank AG, Bank of America Corp., Citigroup Inc. and Barclays Plc declined to comment.
For the vast majority of deals, the acquisitions themselves are not in doubt. If the banks are unable to syndicate the loans to institutional investors before closing, they are typically required to come up with the cash, and may try to offload the debt at a later date.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$0.1 billion and year to date flows stand at $2.0 billion. New issuance for the week was $3.1 billion and year to date issuance is at $63.7 billion.
(Bloomberg) High Yield Market Highlights
It’s looking like a risk-off day in the junk-bond market as stock futures fall amid renewed concerns about the spread of the coronavirus outside China.
CAA yields, meanwhile, have crossed the 10% mark for the first time in three weeks.
Issuers are likely to remain on the sidelines Friday and the calendar is light, though Bausch Health is expected to emerge with a $3.25b junk-bond that’s part of a broader $8b refinancing
Yields rose 4bps to 5.13%, the biggest jump in three weeks though the index posted a modest gain of 0.018%
BA yields rose 4ps to 3.64%, single-B yields rose to 5%
(Bloomberg) Macy’s, Renault Add to Fallen Angel Fear With Downgrades to Junk
The credit-rating downgrades of Macy’s Inc. and Renault SA to junk status are rekindling fears among investors of a potential uptick in so-called fallen angels after a run of relative tranquility in the U.S. corporate bond market.
The American retailer and French carmaker each lost an investment-grade rating Tuesday, affecting billions of dollars of debt. They follow Kraft Heinz Co., the iconic U.S. packaged-food company, which was downgraded to junk by two credit raters last Friday as its turnaround shows little signs of progress.
Even though Macy’s and Renault were downgraded for idiosyncratic reasons and will still trade in investment-grade indexes unless another credit-rating company follows suit, their cuts bring back to the fore what had been a central concern among investors less than two years ago: That a slowing global economy could hamper companies’ ability to service their obligations, especially those that had taken on significant debt loads to finance deals.
While many firms took actions to reduce debt levels in 2019, several are still proving to be susceptible to ratings risk. Kraft Heinz alone, with around $21 billion of debt leaving the Bloomberg Barclays investment-grade index at the end of this month, nearly eclipses last year’s fallen angel volume of just under $22 billion, according to Bank of America Corp. strategists. Macy’s has about $8 billion of total debt, while Renault’s roughly $66 billion is predominantly denominated in euros and yen, according to data compiled by Bloomberg.
By year-end, the volume of fallen angels is likely to dwarf that of 2019, according UBS Group AG strategists led by Matthew Mish. They predict there could be as much as $90 billion of investment-grade debt downgraded to high yield this year. Guggenheim Partners has said as much as 20% of BBBs in the U.S., or $660 billion, will get cut to junk in the next downgrade wave.
(Reuters) U.S. labor market remains strong; manufacturing likely stabilizing
The number of Americans filing for unemployment benefits rose modestly last week, suggesting sustained labor market strength that could help to support the economy amid risks from the coronavirus and weak business investment.
There was encouraging news on the struggling manufacturing sector, with other data on Thursday showing factory activity in the mid-Atlantic region accelerated to a three-year high in February, likely as tensions in the 19-month trade war between the United States and China diminished.
But the coronavirus, which has killed more than 2,000 people, mostly in China, and Boeing’s suspension last month of the production of its troubled 737 MAX jetliner, grounded in March 2019 after two fatal crashes, continue to loom over the manufacturing sector.
Minutes of the Federal Reserve’s Jan. 28-29 meeting published on Wednesday showed policymakers “expected economic growth to continue at a moderate pace,” but expressed concern about possible economic risks from the coronavirus, which has also infected thousands globally.
“Manufacturing growth may be past its trough,” said Oren Klachkin, lead U.S. economist at Oxford Economics in New York. “However, looking ahead we continue to believe that activity will advance at a lackluster pace as global growth and trade policy headwinds are unlikely to significantly relent and the negative impact of the coronavirus will be felt via global supply chains interlinkages.”
(Bloomberg) Aecom Conference Cancellation May Increase Deal Rumblings
Reports on Aecom not attending two industrial conferences this week are being “seen as a positive indication that the company might be in later-stage negotiations for a deal,” Baird analyst Andrew Wittmann wrote in a note.
Baird confirmed that Aecom canceled from a Citi conference, and is not in attendance at a Barclays conference
Wittmann noted previous reports that Aecom had been approached by WSP Global regarding a deal
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $2.4 billion and year to date flows stand at $3.7 billion. New issuance for the week was $12.4 billion and year to date issuance is at $60.6 billion.
(Bloomberg) High Yield Market Highlights
Zayo Group Holdings Inc. is readying more than $3 billion of junk bonds, one of the biggest buyout financings since 2018 that may test investor appetite for riskier debt in the CAA tier.
The new notes, along with a leveraged loan package totaling more than $5b, will finance Zayo’s buyout by private equity firms Digital Colony Partners and EQT Partners
The bond portion of the offering may include $1b of seven-year secured notes and $2.1b of unsecured eight-year bonds, and marketing begins next Tuesday
It’s hitting the market after two straight weeks of gains for junk- bonds, which looks set to continue on Friday as stock futures edge higher and oil climbs
Triple C rated bonds have lagged the broader high-yield market so far this year, returning 0.942% through Thursday while the larger junk universe rose 1.11%
Yet CAA index yields have still fallen to a nine-month low of 9.71% and posted positive returns for three consecutive sessions this week. Other issuers, including Hecla Mining, have also priced debt in this rating range
Investors have plenty of cash to put to work too after corporate high-yield funds reported inflows
BA and single-B yields have fallen to a three- week low of 3.59% and 5%, respectively
BAs have gained for ten straight sessions, taking year-to-date returns to 1.175%
(Bloomberg) Natural Gas Tumbles to 4-Year Low on ‘Epic’ U.S. Demand Loss
Natural gas futures sank to a four-year low as the latest U.S. forecasts all but eliminated bulls’ hopes for a late-winter cold push.
Frigid weather in parts of the Midwest and West this week won’t stick around for long, according to Commodity Weather Group LLC. Mild temperatures are poised to blanket the eastern half of the country in late February, a shift from previous outlooks that showed a lingering chill.
Unusually warm winter weather has wreaked havoc on gas demand, allowing an onslaught of supply from shale basins to overwhelm the market. American liquefied natural gas cargoes, a key outlet for production, are at risk of being curtailed as the coronavirus outbreak in China curbs consumption in the world’s second-largest economy. The resulting collapse in global gas prices is squeezing profits for U.S. exporters.
“The lack of heating demand is epic. It’s a worst-case scenario,” John Kilduff, founding partner at hedge fund Again Capital LLC in New York, said by phone. “We continue to have a very weak demand environment that’s persisted all winter.”
The gas glut has been especially severe in the Permian Basin, where local prices for March delivery have dropped below zero. Output from the West Texas and New Mexico shale play, where gas is extracted as a byproduct of oil drilling, is increasing so fast there isn’t enough space on pipelines to take it away.
(Reuters) T-Mobile-Sprint merger wins approval from U.S. judge
T-Mobile edged closer to a takeover of Sprint Corp after a federal judge on Tuesday approved the deal, rejecting a claim by a group of states that said the proposed transaction would violate antitrust laws and raise prices.
During a two-week trial in December, T-Mobile and Sprint argued the merger will better equip the new company to compete with top players Verizon Communications Inc and AT&T Inc as the third-largest U.S. wireless carrier, creating a more efficient company with low prices and faster internet speeds.
Finalizing a deal will be a boon to Japan’s Softbank Group Corp, Sprint’s controlling shareholder, as the conglomerate offloads a troubled asset that has lost subscribers at a faster rate and as it seeks to secure funding for a second Vision Fund.
Sprint and T-Mobile said in a statement that they would move to finalize the merger, which is still subject to closing conditions and possible additional court proceedings.
A spokesman for the California Public Utilities Commission, the last regulatory body to decide on the merger, said its review of the deal is expected to conclude in July.
(Wall Street Journal) MGM Resorts Chief Set To Step Down
MGM Resorts International Chief Executive Jim Murren will leave the global casino operator after its board picks his successor, the company said.
Mr. Murren, who is also stepping down as chairman, has led the company since 2008. He is leaving before his contract expires at the end of 2021.
“When I thought through how I could best serve MGM going forward, I thought it was pretty clear that a leader should help lead a company into the next decade or two,” Mr. Murren said on a conference call with Wall Street analysts on Wednesday. “I wanted to make sure the board had the time, which it will use promptly, to do a robust search and find my successor.”
MGM Resorts, which has a market value of $17 billion, didn’t give a firm date for Mr. Murren’s departure. The board has formed a search committee to find a new CEO, the company said. Mr. Murren said he anticipates being on MGM Resorts’ next quarterly earnings call, in about three months.
The company has sold off much of its real estate, including deals with MGM Growth Properties, a real-estate investment trust MGM Resorts spun off in 2016, and other property deals. The company’s “asset-light” strategy is intended to pull cash out of the company’s valuable real estate, including prime locations on the Las Vegas Strip.
MGM Resorts’ remaining company-owned real estate includes MGM Springfield in Massachusetts, a 50% stake in CityCenter in Las Vegas and more than half of MGM Growth Properties.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.1 billion and year to date flows stand at $1.2 billion. New issuance for the week was $12.5 billion and year to date issuance is at $48.2 billion.
(Bloomberg) High Yield Market Highlights
New issues have been well-received
Yet it’s looking like a risk-off day as stock futures slide on renewed fears of the spread of the coronavirus
Junk- bond yields have fallen 24bps in the past week. At 5.28%, they’re just 30bps off the 5.5-year low hit on Jan. 21
Spreads have tightened 34bps over the same period to 356bps over Treasuries
Even riskier debt has rallied with yields on CAAs falling below 10% for the first time in two weeks to 9.95%
Junk- bond investors are pouring money back into exchange-traded funds again
HYG and JNK, the two biggest high-yield ETFs, reported a combined inflow of $325m yesterday after $630m the previous day
(New York Times) Some Takeaways From Trump’s State of the Union Address
President Trump framed his third year in office as an unmistakable success and his fourth as more of the same.
A partisan atmosphere loomed over the House floor from the very start of Mr. Trump’s speech, when Republican lawmakers chanted “four more years” after the president stepped up to the rostrum. The hostility carried through to the end, when House Speaker Nancy Pelosi ripped up a copy of the address after he finished delivering it.
He proclaimed that the economy was setting records, that American enemies were on the defense, and that the American spirit had been renewed.
“In just three short years, we have shattered the mentality of American decline and we have rejected the downsizing of America’s destiny,” he said. “We are moving forward at a pace that was unimaginable just a short time ago and we are never going back.”
Trump dived into the state of the economy at the top of the speech, making broad declarations about tax cuts, deregulation and the renegotiation of the North American Free Trade Agreement, the new version of which he signed into law last week.
Trump addressed two pieces of potential health care legislation that remain a top priority for both parties in the coming months: surprise billing and prescription drugs.
After signing an initial trade deal with China last month, Mr. Trump pointed on Tuesday to the tariffs he has imposed on the country in order to take on its “massive theft of America’s jobs.” He said that “our strategy has worked.”
Trump’s attention on foreign policy later swung to the Middle East, when he highlighted two people his administration killed in recent months: Abu Bakr al-Baghdadi, the leader of the Islamic State, and Maj. Gen. Qassim Suleimani, the powerful Iranian commander.
(Wall Street Journal) Ford’s Operating Income Plunges
Ford Motor Co. said fourth-quarter operating income sank by two-thirds, and it issued a lower-than-expected profit outlook for 2020, the latest signs of trouble for Chief Executive Jim Hackett’s turnaround plan.
Ford said operating income for the October-to-December period was $485 million, down from $1.5 billion a year earlier. Earnings per share adjusted for one-time items were 12 cents, well short of analysts’ estimate of 17 cents.
The company’s financial standing has continued to weaken under Mr. Hackett, who was brought in nearly three years ago to revive the auto maker’s profit growth and give it a stronger vision for the future.
Revenue for the full year dropped 3% to $155.9 billion.
“Financially, it wasn’t OK,” finance chief Tim Stone said of the 2019 results during a discussion with reporters at Ford’s headquarters. “Strategically. . .I think we made strong progress.”
Ford pinned the shortfall in part on lower production volumes in North America stemming from problems with launches of key models, including the redesigned Explorer and Escape sport-utility vehicles and its Super Duty pickup truck. It also cited higher warranty costs and a bonus payout to United Auto Workers that totaled about $600 million.
The auto maker forecast operating profit this year of $5.6 billion to $6.6 billion, compared with $6.38 billion last year. That equals an earnings-per-share range of 94 cents to $1.20, which is lower than the average analysts’ estimate of $1.30, according to S&P Global Market Intelligence.
Hackett’s strategy to revitalize Ford — which includes a multiyear, multibillion-dollar restructuring — hasn’t returned the company to earnings growth or restored profitability overseas, where Ford is closing plants and shedding thousands of workers to cut costs.
“Financially, the company’s 2019 performance was short of our original expectations, mostly because our operational execution — which we usually do very well — wasn’t nearly good enough,” Mr. Hackett said. “We recognize, take accountability for and have made changes because of this.”
In a bright spot for the year, Ford trimmed its losses in overseas markets. It halved its China loss, to $771 million from $1.55 billion, which it attributed to cost cutting. In Europe, the company had a $47 million loss for the year, down from a $398 million loss a year earlier.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$2.7 billion. New issuance for the week was $8.2 billion and year to date HY is at $35.7 billion.
(Bloomberg) High Yield Market Highlights
S. junk-bonds are heading for their second weekly loss amid fears about the spreading coronavirus from China. Investors pulled $2.7 billion from high-yield retail funds, the biggest cash withdrawal in almost six months, and exchange-traded funds are continuing to leak cash.
Junk-bond returns turned negative for the second time this week posting a loss of 0.16% Thursday. The CAA index posted losses of 0.17% and is also set for its second weekly declines
Those falls may extend Friday with stock futures lower. Oil prices are higher this morning, but fell to an almost six-month low on Thursday, weighing on the high-yield energy index
Junk bond yields rose 9 basis points to 5.49%, the biggest weekly jump since October, while spreads widened 11 basis points to 382 basis points over Treasuries
Single-B yields jumped 10 basis points to 5.46%, while CAA yields rose 9 basis points to 10.32%
The two biggest high-yield ETFs — HYG and JNK — saw a combined outflow of $547 million in the last session as outflows continue
(Business Wire) Arconic Reports Financial Results
Arconic Inc. reported fourth quarter 2019 and full year 2019 results. The Company reported fourth quarter revenues of $3.4 billion, down 2% year over year. Organic revenue was up 1% year over year on growth in the aerospace, packaging and industrial markets and favorable product pricing, largely offset by weakness in the automotive, commercial transportation, and building and construction markets.
Operating income excluding special items was $444 million, up 37% year over year, driven by net cost reductions, favorable product pricing, and favorable aluminum and raw material costs, partially offset by lower volumes in automotive and commercial transportation. Full year 2019 operating income was $1.0 billion versus $1.3 billion in the full year 2018. Operating income excluding special items for full year 2019 was $1.8 billion versus $1.4 billion in the full year 2018, driven by favorable product pricing; net cost reductions; volume growth in aerospace, packaging and commercial transportation markets; and favorable aluminum and raw material costs. These impacts were partially offset by unfavorable product mix.
Arconic Chairman and Chief Executive Officer John Plant said, “In 2019, the Arconic team delivered improved revenue, adjusted operating income, adjusted operating income margin, adjusted free cash flow and adjusted earnings per share. Arconic’s 2019 return on net assets improved by 450 basis points year over year to 13.7%.”
(Bloomberg) Fed Holds Main Rate as Powell Stresses Need to Hit 2% Inflation
The Federal Reserve kept its key interest rate unchanged and continued to signal policy would stay on hold for the time being, while stressing the importance of lifting inflation to officials’ target.
The central bank also made a technical adjustment to the rate it pays on reserve balances and said it would extend at least through April a program aimed at smoothing volatility in
money markets.
“We believe monetary policy is well positioned to serve the American people by supporting continued economic growth,” Chairman Jerome Powell told a press conference Wednesday in Washington.
Officials kept the target range of the benchmark federal funds rate at 1.5% to 1.75% and called that stance “appropriate to support sustained expansion of economic activity.”
S. stocks erased gains while yields on the 10-year Treasury note declined and the dollar fluctuated. Traders extended bets the Fed would cut rates toward the end of this year.
“The Fed has made it clear that the barriers to move in either direction are quite high,” said said Daniel Ahn, the chief U.S. economist at BNP Paribas. “But we believe the wall
for a cut is lower than the wall for a hike.” He detected a “dovish tilt” in Powell’s efforts to stress the Fed was uncomfortable with inflation running persistently too low.
Policy makers changed their statement to say that the current stance of monetary policy is appropriate to support “inflation returning to the committee’s symmetric 2% objective.” Previously they had said policy was supporting inflation “near” the goal.
Powell explained in his press conference that the change was made to send “a clearer signal” that the committee was not comfortable with inflation running persistently below target. “We wanted to underscore our commitment to 2% not being a ceiling,” he said.
Their preferred gauge of price pressures — the personal consumption expenditures price index — rose 1.5% for the 12 months ending in November. Powell said inflation was expected to move closer to 2% over the next few months thanks to so-called base effects, “as unusually low readings from early 2019 drop out of the calculation.”
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.9 billion. New issuance for the week was $13.2 billion and year to date HY is at $27.4 billion.
(Bloomberg) High Yield Market Highlights
S. junk bonds posted a third straight day of losses as issuance neared $32 billion, the most for a January in more than a decade.
Borrowers are rushing to take advantage of low rates before the window closes
Markets may see support today as stock futures climb on economic data and investors set aside concerns about a deadly virus from China hampering growth
Yields rose 8bps to 5.17%, a three week high, as stocks fluctuated and oil dropped to an eight-week low
Spreads widened 8bps to +340, a six week high
Energy yields jumped 30bps to 8.56%, the biggest increase in more than five months
Energy index posted a loss of 0.675%, the biggest loss since October,
CAA yields were back at 10%, returns were negative for a third day
Retail funds have reported three straight weeks of inflow, the longest streak in almost three months
(Wall Street Journal) Glut Pushes Natural Gas Prices Below $2
The price of natural gas typically rises this time of year as temperatures plunge and homeowners dial up their thermostats. Instead, the price of the heating and electricity-generating fuel has dropped to multiyear lows.
On Tuesday, natural-gas futures fell below $2 per million British thermal units to their lowest level in nearly four years, highlighting how a persistent glut has buffeted energy investors and producers. This winter’s mild weather has joined an oversupply of the commodity to push natural-gas prices down to levels not seen since March 2016. On Tuesday, futures fell 5.4% to $1.895 per MMBtu.
The shale boom, spurred by horizontal drilling and hydraulic fracturing techniques, has transformed the U.S. energy industry and flooded the market with oil and natural gas in recent years. The decline in prices has hit shares of energy companies, raising calls for them to curtail production. But few analysts see signs of the glut abating soon: The U.S. Energy Information Administration predicts dry natural-gas production in the U.S. will rise by 2.9% in 2020.
The fall in prices has come faster than analysts and traders had predicted. Colder winter temperatures typically drive up prices as homeowners demand more fuel to heat their houses. However, warmer-than-expected weather this season has helped drive prices down, adding to investors’ grim outlook.
On Tuesday, oil-field services company Halliburton Co. said it swung to a loss in 2019 on a decline in revenue that it blamed on diminished drilling onshore in North America, which in turn was due to low commodity prices.
“Gas prices in the U.S. are below break-even levels,” Chief Executive Jeffrey Miller told analysts and investors. Mr. Miller said that he expects a 10% reduction in spending among the oil-field services company’s customers in North America, with the bulk of those cuts coming in gas-producing regions. Halliburton has been idling equipment to match customers’ reduced needs, he said.
(Bloomberg) Junk Bond Volume Nears $30 Billion in Refi Frenzy
The U.S. junk-bond market is on track for its busiest January in at least a decade with volume poised to exceed $30 billion as companies rush to refinance at cheap rates.
At least seven issuers are looking to sell debt on Thursday after an already hectic pace. Those deals will potentially take new issue volume to $30.8 billion, the most for any January since 2006, according to data compiled by Bloomberg
Companies are mostly selling debt to refinance. Some of those issuers are replacing loans with bonds
Garda World Security, owned by private-equity firm BC Partners, is marketing $400 million 7 year senior secured notes to take out a term loan
It’s at least the third company to do so this month amid more favorable pricing — in some cases — for bonds
Another BC Partners portfolio company, Presidio, priced secured bonds at a cheaper rate than loans last week
Grocer Albertsons also sold $2.35 billion of bonds on Wednesday to refinance loans
The primary market appears open to the deals in the lowest CAA junk rating tier. Community Health and Altice are in market with bonds that have at least one rating in that range
Junk-bond spreads widened to a two-week high on Wednesday, and may weaken more as stocks fall and oil prices fall to an almost eight-week low of $55.51 a barrel
In the fourth quarter of 2019, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was 2.62% bringing the year to date (“YTD”) return to 14.32%. The CAM High Yield Composite gross total return for the fourth quarter was 2.37% bringing the YTD return to 16.31%. The S&P 500 stock index return was 9.06% (including dividends reinvested) for Q4, and the YTD return stands at 31.48%. The 10 year US Treasury rate (“10 year”) drifted higher throughout the quarter finishing at 1.92%, up 0.26% from the beginning of the quarter. During the quarter, the Index option adjusted spread (“OAS”) tightened 37 basis points moving from 373 basis points to 336 basis points. During the fourth quarter, each quality segment of the High Yield Market participated in the spread tightening as BB rated securities tightened 33 basis points, B rated securities tightened 46 basis points, and CCC rated securities, tightened 22 basis points.
The Banking, Finance, and Basic Industry sectors were the best performers during the quarter, posting returns of 3.56%, 3.54%, and 3.25%, respectively. On the other hand, REITs, Communications, and Other Financial were the worst performing sectors, posting returns of 1.30%, 1.74%, and 2.00%, respectively. At the industry level, autos, wirelines, pharma, and oil field services all posted the best returns. The automotive industry (4.97%) posted the highest return. The lowest performing industries during the quarter were tobacco, retail REITs, leisure, and cable. The tobacco industry (-3.08%) posted the lowest return.
During the fourth quarter, the high yield primary market posted $81.4 billion in issuance. Issuance within Consumer Discretionary was the strongest with 18% of the total during the quarter. The 2019 fourth quarter level of issuance was much more than the $16.9 billion posted during the fourth quarter of 2018. Wall Street strategists are calling for slightly less overall issuance in 2020. However, the issuance is likely to remain focused on refinancing.
The Federal Reserve held two meetings during Q4 2019, and the Federal Funds Target Rate was reduced 0.25% at October meeting and held steady at the December meeting. The rate reduction marked the third move lower of the Target Rate in 2019. While the past four Fed meetings had dissenting members, the vote to hold steady was unanimous among the voting members. Chairman Powell commented, “our economic outlook remains a favorable one despite global developments and ongoing risks. As long as incoming information about the economy remains broadly consistent with this outlook, the current stance of monetary policy likely will remain appropriate.” Although Chair Powell’s comments point to the Fed continuing to hold rates flat; as of this writing, investors are pricing in a 54% probability of a cut by the FOMC during 2020.i While we are interest rate agnostic and do not attempt to time interest rate movements, we are very aware of the impact Fed policy has on the markets. Therefore, we will continue to monitor this very important theme throughout 2020.
While the Target Rate moves tend to have a more immediate impact on the short end of the yield curve, yields on intermediate Treasuries increased 26 basis points over the quarter, as the 10-year Treasury yield was at 1.66% on September 30th, and 1.92% at the end of the quarter. The 5-year Treasury increased 15 basis points over the quarter, moving from 1.54% on September 30th, to 1.69% at the end of the quarter. Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. Inflation as measured by core CPI has been testing the upper bound of the last several years. The most recent print was 2.3% as of the December 11th report. The revised third quarter GDP print was 2.1% (quarter over quarter annualized rate). The consensus view of economists suggests a GDP for 2019 around 1.8% with inflation expectations around 2.1%.
The chart above shows that two year to ten year Treasury spread has reached the highest level in over a year. It seems like ages since a main theme was yield curve inversion. The dip in the ratio through August was “driven by deepening pessimism over the global outlook amid rising trade tensions and a string of weak manufacturing data.”ii Since that time, China and the U.S. have reached agreement on Phase 1 of a trade deal, the Fed has begun lowering rates for the first time in over a decade, and investor sentiment has improved.
President Trump was impeached by the House of Representatives in December. The market shrugged off the news fully expecting the Senate to provide an acquittal. Meanwhile, the agreed upon Phase 1 trade deal “will see lower U.S. tariffs on Chinese goods and higher Chinese purchases of U.S. farm, energy and manufactured goods.”iii Additionally, intellectual property protections are to be increased by the Chinese. Across the Atlantic, Brexit is looking more and more likely. Britain’s exit from the European Union still has some hurdles to jump, but U.K. Prime Minister Boris Johnson is pressing to deliver by the January 31, 2020 cutoff.
Being a more conservative asset manager, Cincinnati Asset Management is structurally underweight CCC and lower rated securities. This positioning has served our clients well in 2019. As noted above, our High Yield Composite gross total return has outperformed the Index over the YTD measurement period. With the market remaining robust during the fourth quarter, our cash position remained the largest drag on our overall performance. Further, our structurally underweight of CCC rated securities was a headwind as that group saw a pop in Q4 after lagging in Q2 and Q3. Additionally, our underweight positioning in the energy exploration & production and oil field services industries were a drag on our performance. Further, our credit selections within the consumer non-cyclical sector and wireline industry hurt performance. However, our underweight in the cable industry and our overweight in the consumer cyclical sector were bright spots. Further, our credit selections within the midstream and automotive industries were a benefit to performance.
The Bloomberg Barclays US Corporate High Yield Index ended the fourth quarter with a yield of 5.19%. This yield is an average that is barbelled by the CCC-rated cohort yielding 10.43% and a BB rated slice yielding 3.63%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), remained fairly muted ending the quarter just under 14 down about 2 points. The fourth quarter had seven issuers default on their debt. The twelve month default rate was 2.63% and has been driven by default volume in the energy and metals & mining sectors. Excluding those two sectors from the data, the default rate would fall to only 1.26%.iv Additionally, fundamentals of high yield companies continue to be mostly good. From a technical perspective, supply has increased from the low levels posted in 2018, and flows have been positive relative to the negative flows of 2018. Due to the historically below average default rates, the higher yields available relative to other spread product, and the diversification benefit in the High Yield Market, it is very much an area of select opportunity that deserves to be represented in many client portfolio allocations.
With the High Yield Market remaining very firm in terms of performance, it is important that we exercise discipline and selectivity in our credit choices moving forward. With the market seemingly tight on a yield and spread basis relative to the last couple of decades, we are on the lookout for pitfalls as well as opportunities for our clients. The market needs to be carefully monitored to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. It is important to focus on credit research and buy bonds of corporations that can withstand economic headwinds and also enjoy improved credit metrics in a stable to improving economy. As always, we will continue our search for value and adjust positions as we uncover compelling situations.
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 January 2, 2020, 4:00 PM EDT: World Interest Rate Probability (WIRP)
ii Bloomberg December 19, 2019: “Yield Curve Hits Steepest Since 2018 as Inflation Risks Eyed”
iii Reuters December 19, 2019: “China says in touch with U.S. on signing of Phase 1 trade deal”
iv JP Morgan January 2, 2020: “Default Monitor”
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $2.0 billion. New issuance for the week was $8.1 billion and year to date HY is at $14.2 billion.
(Bloomberg) High Yield Market Highlights
Triple C-rated debt is leading the rally in high-yield as returns for the year jump to 1.23% and yields on the lowest tier of junk fall below 10% for the first time in seven months.
Triple C spreads tightened 10bps to 823bps over Treasuries, according to Bloomberg Barclays index data. That’s a more than five-month low and extends a recovery from over 1,000 bps in November
Energy is powering CCC. The energy index yield fell to 7.99%, a new six-month low
Junk-bond yields dropped to 5.01%, just 5bps off the 5.5-year low of 4.96%. They may fall further as stock futures rise amid easing trade tensions and a solid start to the earnings season. Oil is also up this morning to almost $59 a barrel
(Bloomberg) Encompass Health Boosts Fiscal Year Operating Revenue View
Encompass Health boosted its operating revenue forecast for the full year; the guidance midpoint met the average analyst estimate.
Encompass sees FY operating revenue $4.59 billion to $4.61 billion, saw $4.5 billion to $4.6 billion, estimate $4.59 billion (range $4.57 billion to $4.61 billion)
Encompass sees FY adjusted EPS from continuing operations $3.90 to $3.94, saw $3.71 to $3.85
Encompass sees FY adjusted Ebitda $962 million to $967 million, saw $940.0 million to $960.0 million, estimate $952.2 million (range $942.0 million to $957.0 million)
Encompass sees 2020 Adjusted EPS Continuing Operations $3.50 to $3.72, Est. $3.68
(Bloomberg) WSP Is Said to Approach Engineering Firm Aecom About Deal
Canada’s WSP Global Inc. has approached rival engineering services firm Aecom about a possible deal, according to people familiar with the matter. There’s no guarantee that the overture will lead to a transaction, said the people, who asked to not be identified
because the matter isn’t public.
Aecom, which had been targeted by activist investor Starboard Value last year, agreed in October to sell its management services division to a group of private equity firms
for $2.4 billion.
The potential acquisition would give WSP more exposure to the U.S. and could lead to cost savings of about $200 million, Deutsche Bank analyst Chad Dillard wrote in a note to clients Tuesday.
Aecom’s services include consulting, planning, architecture, engineering and construction management, according to its website. While it has a growing backlog thanks to a steady stream of government and infrastructure contracts, profits have stagnated in recent years due to inefficiencies and construction contract
losses, according to a Bloomberg Intelligence report in December.
(Wall Street Journal) MGM, Blackstone Strike Casino Deal
MGM Resorts International said a joint venture that includes Blackstone Group Inc. would buy the real estate of the MGM Grand and Mandalay Bay resorts and casinos on the Las Vegas Strip, in a deal valuing the properties at $4.6 billion.
The deal values MGM Grand’s real-estate assets at about $2.5 billion and Mandalay Bay’s at just over $2 billion.
Blackstone will own slightly less than half of the properties through the private-equity and real-estate giant’s nonlisted real-estate investment trust, while MGM Growth Properties LLC, a publicly traded REIT, will own the remainder.
MGM Resorts spun off MGM Growth Properties in 2016 and still controls the REIT, which owns some MGM real estate including Mandalay Bay’s.
MGM Resorts expects to receive cash proceeds of about $2.4 billion from the deal, as well as $85 million in MGM Growth partnership units.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.9 billion and new issuance for the week $6.1 billion.
(Bloomberg) High Yield Market Highlights
S. high-yield bonds are set for the longest streak of weekly gains since the first half of 2019 as the global hunt for yield continues to bolster the market.
The Bloomberg Barclays U.S. high-yield index has posted gains each day this week as yields held steady at 5.11% through Thursday, one basis point lower on the week.
The high-yield energy index weighed on performance as oil prices lost steam earlier in the week. The securities posted losses for the second consecutive day on Thursday, losing 0.13%; yields on energy bonds ended at 8.12%.
Even while oil prices dropped back to levels before the Mideast tensions began, issuance activity was driven by energy borrowers.
(Reuters) Fed focuses on repo market exit strategy after avoiding year-end crunch
Wall Street’s worst fears of a year-end funding squeeze never materialized thanks in large part to the quarter-trillion dollars the Federal Reserve stuffed into the market to ensure nothing became gummed up.
The question now, though, is what it will take for the U.S. central bank to withdraw from its daily liquidity operations in the $2.2 trillion market for repurchase agreements, or repos – after it became a dominant player in a short three months.
“The repo operations are a band-aid, but the wound isn’t healed fully,” said Gennadiy Goldberg, an interest rate strategist at TD Securities.
The New York Fed began injecting billions of dollars of liquidity into the repo market in mid-September, when a confluence of events sent the cost of overnight loans as high as 10%, more than four times the Fed’s rate at the time. A month later, the Fed moved to expand its balance sheet – and boost the level of reserves – by snapping up $60 billion a month in U.S. Treasury bills.
The Fed will continue pumping tens of billions a day into the repo market through at least the end of January. Its ability to exit from the repo market after that time will depend on how long it takes the central bank to make the balance sheet large enough so there are adequate reserves in the banking system – and the repo operations are no longer needed.
“It seems implausible to me that the Fed will be able to stop their repo operations by the end of January,” said Mark Cabana, head of U.S. rates strategy at Bank of America Merrill Lynch.
(Company Report) Tenneco Inc. plans to streamline its leadership structure
The Company announced that Brian Kesseler, Tenneco’s Co-Chief Executive Officer and a member of the Board of Directors, will assume the newly consolidated role of Chief Executive Officer of Tenneco. Kesseler will oversee the operations of the New Tenneco business, in addition to continuing to oversee the DRiV business. Roger Wood will no longer serve as Tenneco’s Co-Chief Executive Officer and is stepping down as a Director of the Company, effective immediately.
Jason Hollar will continue to serve as Executive Vice President and Chief Financial Officer of Tenneco overseeing the financial organizations of both DRiV and New Tenneco.
“On behalf of the Board of Directors, I would like to thank Roger for his dedication to Tenneco during a critical time for our company,” said Gregg M. Sherrill, Chairman of the Tenneco Board. “We appreciate his service and contributions in leading the New Tenneco business as we began the integration of the Federal-Mogul acquisition. As we pursue the separation of our businesses, the Board determined that consolidating our leadership structure now will help improve Tenneco’s operational efficiency and achieve our near-term financial performance objectives. We wish Roger the very best in his future endeavors.”
During 2020, Tenneco will be focused on the execution of its accelerated performance improvement plan to facilitate the expected separation of the businesses.
As previously discussed in the Company’s third quarter release on October 31, 2019, current end-market conditions are affecting the Company’s ability to complete a separation in the mid-year 2020 time range. The Company expects that these trends will continue throughout this year. The Company is ready to separate the businesses as soon as favorable conditions are present.
This is an abbreviated Note due to the Thanksgiving holiday. Happy Thanksgiving!
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.2 billion and year to date flows stand at $23.5 billion. New issuance for the week was $12.8 billion and year to date HY is at $251.1 billion, which is +55% over the same period last year.
(Bloomberg) Single and Double B Junk Bond Returns Hit 2019 Peak Amid Rally
Junk bond returns are creeping back to record highs after three consecutive days of gains.
Junk bond year-to-date returns rose to 11.928%, inching closer to the highs of just over 12% reached earlier this month. Index yields were unchanged, closing at a two-week low of 5.64%
BB returns hit a year-to-date peak of 13.944%, while single B returns set a new high at 12.553%
CCCs are also catching a bid, boosted by a lift in energy bonds, after posting gains for three straight sessions to take year-to-date returns to 4.101%. That comes less than a week after CCC spreads jumped above 1,000bps over U.S. Treasuries for the first time in more than three years
