Saturday, October 17, 2015

Some Things You'd Better Know About the Debt Markets

If you are going to have any chance at all in the Global Macro racket-and not be just a macro tourist- you must internalize the interplay of credit markets and currencies and equities and interest rates and the price of corn in Illinois such that when you tug on any part of the tapestry you know how the other parts are going to react.

And then when they don't react the way theory says they should, you pull all bets, try to figure out what happened and maybe have a chance to make real money.

From FT Alphaville:

Debt markets cannae take much more? 
AB InBev – SABMiller
Dell – EMC (Per CreditSights: “We believe that Dell has signed up to do the unthinkable – raise about $40 billion of debt”)
x – Sandisk (supposedly)
Maxim – Analog Devices (supposedly)

All of that action has lead UBS’s Matthew Mish and Stephen Caprio to ask if debt markets are reaching full capacity in this late stage of the credit cycle (with our emphasis):
What we find interesting is that most issuers and equity investors do not consider the prospect that debt markets could be reaching a point of full capacity – at least not in the near term. There are two root causes of this belief, in our view. First, neither has a strong appreciation of the divergences between debt and equity market universes. First, equity investors typically focus on large cap benchmarks (e.g., S&P 500) – of which most of the market capitalization lies in the top 100 firms – and generally see strong balance sheets with low net leverage, many of which are rated single and double A. However, that is not what credit investors view in their own universe. By definition, while equity indices weighted by market capitalization have been biased towards higher quality companies which have low debt and high cash balances, debt indices weighted by debt outstanding have been skewed towards those issuers raising more debt and generally levering up (Figure 1). In the US, this first occurred in US leveraged loans (and to a lesser extent high yield) – driven primarily by financially savvy private equity owners; now it is manifesting itself in high grade as strategics lever up balance sheets to juice earnings in an environment where hiking dividends (further), buying back (more) stock, and spending on capex (particularly overseas) appears to have diminishing marginal returns. Second, this cohort perceives low rates as a key stabilizer for financing costs. As we argued last week, low Treasury yields are a key source of support for high grade bond yields. In recent months, even as IG credit spreads have widened, government bond yield declines have helped soften the overall impact on funding costs. For high yield yields, however, the major component is credit spreads, so low Treasury yields can only do so much.
The real point, which they say is not confined to the US, is that there is an unappreciated divergence in fundamentals in equity and debt markets — which you can see in the net leverage figures....MUCH MORE
See also: Lessons from the TMT bust for today’s high-yield investors?