It is not every day that notable investors come out of retirement to establish short positions, Wall Street strategists give “throw in the towel” advice to their clients, hedge fund managers tell their investors to sell everything except for Gold, and presidential candidates and central bankers alike are warning about developing asset bubbles. The good news for readers is I am not going to join this Triple G crowd – (Buy a Gun, Buy Gold, Pray to God). Instead, I am going to focus on the dynamics within Corporate America and how companies are navigating and in some ways capitalizing on the prevailing market backdrop.
The key drivers of corporate bond issuance are all in force, leading to $147 billion of corporate new issue volume since Labor Day – i.e. refinancings, M&A, share repurchase and liability management. Mizuho has continued its momentum by serving as a bookrunner on twenty-one corporate bond offerings for $42.1 billion in proceeds over this same time period. We continue to be impressed by the resilience of the corporate bond market, particularly when considering the various turns in sentiment we’ve seen over the last couple of weeks in the broader financial markets. However, it is a good reminder that we have been living in a world of suppressed volatility. It remains unclear if the decoupling between the strength of corporate credit from the increasingly negative macro-backdrop will persist. We continue to cite the following risks to market stability as having the greatest impact on the corporate bond market – 1) multiple contractions and bear market correction in equities; 2) uncertainty with central bank policy around the globe; 3) slide in commodities, particularly oil; 4) financial contagion ranging from the European banking sector and/or China. As previously mentioned, let’s focus on the first two risks and some of the impact for corporates.
Concerns Mount for an Equity Market Correction
The obvious starting point given the steady pace of share repurchases by corporates is the record levels of equity prices despite weaker earnings and the low growth economic environment. Let’s face facts, management teams are often able to run intrinsic value studies that demonstrate that the market is underestimating their company which supports that there is “value creation” from buying back stock. This dynamic and the dramatic difference between the cost of debt and cost of equity has led to an increase in leverage that has investors questioning where we stand in the credit cycle – debt/EBITDA has reached 3.08x for non-financial S&P 500 companies. It is also leading to increased rigor by management teams as they size and set the pace of share repurchases given the dichotomy between high stock prices and weakening earnings. According to Factset (September 26, 2016, Cash and Investments Quarterly), quarterly net shareholder distributions by the S&P 500 (ex. Financials) fell to the smallest level since Q12015 – 1.7% decline year-over-year and 13.2% drop since last quarter.
Management teams are cognizant that investors will be monitoring the quality of earnings closely for the second quarter. We also note the revision to recent economic data showing that businesses cut investments in buildings and equipment less than previously estimated while spending more on research and development (Q2 business investment 1% vs-.9% expectation). Despite all the fears an equity market correction has for some, corporates will continue to examine and modify the priorities of capital deployment between traditional business investment and returning capital to shareholders to maximize economic profit while protecting their balance sheets. If corporates were like-minded with the Triple-G crowd we would not see the pick-up in business investment. It is also worth noting that from a risk and strength of corporate balance sheet perspective cash and short term investment balances are at the second largest total in at least ten years: $1.456 trillion for the S&P 500 (ex-financials), according to FactSet.
Central Bankers are Uncertain About the Long Term Impact and Implication of Ultra-low and Negative Rates (*)
Extremely low and in some cases negative interest rates globally have certainly caused significant hand wringing. Central bankers have gone as far as to confess to being unsure of all the consequences of their accommodative policies. Obviously, corporates have been the net beneficiary of these policies being able to raise capital cheaply and diversify their funding sources. For example, European corporates have historically relied more heavily on bank debt within their capital structure. While the markets are still evaluating and judging the efficacy of the ECB’s bond buying program and its ability to stimulate the broader economy, the growth of the European corporate bond market has provided much needed capital relief to the banking industry while also strengthening (i.e. lowering interest expense) and diversifying the capital structure of the corporate sector. For context, the euro-corporate bond market has doubled in terms of annual issuance since 2011 (€98.8 billion vs. €217.9 in 2015). In addition, US corporates are capitalizing on the programs and low borrowing environment to diversify their funding sources by issuing in the Eurobond markets. YTD there has been €226 billion of corporate supply in the Euro market (+15.3% year-over-year), with 20% coming from US corporates as it becomes a more reliable and low cost source of liquidity. Additionally, while corporate strategy will always drive the financing equation, it is clear that the low cost issuance environment has helped facilitate industry consolidating mergers and acquisitions. Year-to-date there have been thirteen M&A related issuances each exceeding $5 billion in size, and total M&A issuance of $229 billion has made up 22% of total supply. Finally, the low absolute level of borrowing rates and inexpensive cost of extension of liabilities due to the flattening credit curve has allowed corporates to redeem outstanding debt early through public tender offers. So far in 2016, there has been $186.3 billion of tenders, exchanges, and consents in the U.S. market – a 9.9% increase over 2015. Clearly, corporates have numerous ways that they can capitalize of the availability of low cost capital in the current environment. Thus, the central bank policy of low rates has bolstered the corporate sector and it can serve as a shock-absorber in the event of economic slowdown or other doomsday scenarios being put forward by others.
We hope that some of these highlights from the corporate sector are useful and serve as a bright spot when so many headlines and pundits are discussing looming disaster.
(*) All corporate issuance volume figures are according to Mizuho database.
This document is NOT a research report under the legal requirements in any country or jurisdiction designed to promote the independence of investment research and is NOT a product of a fixed income research department. This document has been prepared for institutional clients, sophisticated investors and market professionals only, on the basis of publicly available information. This communication has been produced by and for the primary benefit of a syndicate desk. It is not investment research nor considered impartial in relation to the activities of this syndicate desk.