Mergers Could Clog Flow of Junk Bonds

Mergers Could Clog Flow of Junk Bonds

WSJ, Jan. 23, 2014 

By Mike Cherney

Investors' healthy appetite for "junk" bonds may be tested in coming months if two supersize corporate takeovers take place.

Sprint Corp. has been pursuing a possible $31 billion purchase of T-Mobile US Inc., TMUS -3.24% and Charter Communications Inc. has launched an unsolicited $37 billion bid for Time Warner Cable Inc. Both would-be buyers have credit ratings below investment grade and each could sell enough bonds to break Sprint's record $6.5 billion junk-bond sale, set last year.

For years after the financial crisis, the thought of junk-bond-fueled megadeals would have been unthinkable, as Wall Street's merger machine struggled to shake off the rust of the financial crisis. But the $49 billion bond sale in September from Verizon Communications Inc., VZ -0.48% an investment-grade deal that was the largest corporate-bond offering on record, showed corporate executives and bankers alike that almost any sum is within reach.

Now, many investors say Sprint and Charter would likely have little problem selling the new bonds, underscoring the hunger for income-generating investments at a time of uneven economic growth, low interest rates and easy central-bank policy.

"It's a different world than it was just a few years ago," said Craig Elder, fixed-income analyst in the private-wealth-management arm of Robert W. Baird & Co.

Junk-rated bonds in the past have done better than investment-grade debt during periods of rising interest rates, in part because the higher yields on these bonds provide an additional cushion against falling prices.

Gary Herbert, a portfolio manager at Brandywine Global Investment Management, which oversees more than $38 billion in fixed-income assets, said he would consider buying new debt from Sprint or Charter if their mergers come to fruition. His firm has sold some bonds recently to make room for new junk-rated deals in the pipeline, he said.

"There's an appetite from the issuer, there's an appetite from the investor, and so when you have the two meet, it gets done," Mr. Herbert said.

Sprint and Charter would be selling new debt at an opportune time: Many investors say they have bought more bonds from junk-rated companies recently. Investment-grade firms sold about $1.1 trillion and junk-rated companies sold about $361 billion in the U.S. in 2013, according to data provider Dealogic.

Many analysts expect strong bond issuance in 2014 but less than in 2013, since interest rates have risen from last year's lows, increasing borrowing costs for companies. When rates rise, bond prices fall.

Junk bonds now yield 3.68 percentage points more than benchmark U.S. Treasurys. In 2007, before the financial crisis, that figure fell as low as 2.33 percentage points. In contrast, investment-grade corporate bonds are yielding 1.11 percentage points more than Treasurys, compared with recent lows of about 0.76 point in 2005, according to Barclays data.

The figures show that prices on junk debt have more room to rally than investment-grade bonds, some analysts say.

Mr. Herbert said the demand for junk debt was on display last week, when Community Health Systems Inc. sold $4 billion in bonds to help pay for its takeover of another hospital company. He said demand was so strong that he didn't get all the bonds he wanted.

"I think most investors felt the same way," Mr. Herbert said.

There are signs, though, that investors may be overindulging on the debt binge. The amount of debt carried by low-rated U.S. companies is approaching levels seen just before the last recession, according to Standard & Poor's Ratings Services.

Hundreds of billions of dollars of debt is scheduled to come due starting in 2016.

A sharp rise in interest rates or a drop in demand from investors could make refinancing challenging for some weaker borrowers.

"The question becomes, what does the capital market environment look like then?" said David Tesher, a managing director at S&P. "Many investors are concerned, but they can't predict what that environment will look like."

For now, investors are waiting to see whether Sprint and Charter ultimately succeed in their takeover bids. A merger between Sprint and T-Mobile would have to clear regulatory hurdles, and Charter has taken its takeover proposal directly to Time Warner Cable shareholders after being rebuffed by the company's management.

Putri Pascualy, senior credit strategist at Pacific Alternative Asset Management Co., which oversees $16 billion, said she would consider buying bonds from Sprint or Charter, depending on the interest offered on the debt.

She said companies offering large amounts of debt often reduce prices compared with already-outstanding debt in order to lure investors, who can then decide whether to hold the bonds for a period or "flip" them for a quick profit.

"If you could make a quick easy return at the beginning of trading, then in an environment where return is hard to come by, hey, we can't afford to be picky," Ms. Pascualy said.

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Tudor Sees First Global Monetary Policy Divergence Since 2010

Tudor sees first global monetary policy divergence since 2010

Bloomberg News

January 21, 2014

Tudor Investment, the $13.7 billion macro hedge-fund firm run by Paul Tudor Jones, said global central bank policies will diverge this year for the first time since 2010. 

Tudor anticipates the U.S. and U.K. will raise interest rates earlier than expected, while rates will be cut in the euro area this year, according to a Jan. 15 weekly note to investors written by five members of the firm's research team. 

"We believe that 2014 will be a year of contrasts when it comes to the outlook for monetary policy across the major developed markets," Filippo Altissimo, global head of research at Tudor, and four colleagues wrote in the note. "For the first time since 2010, there will likely be an unfolding divergence in monetary policy." 

Betting against Canadian interest rates, as opposed to those in the U.S., may offer "better risk-reward" amid positive economic activity in both countries, according to the note. The Greenwich-based firm is finding near-term value in wagering against U.K. fixed income, "especially around unemployment releases," as it expects the country's rates to rise, while betting on European monetary union debt. 

Macro funds, which wager on macroeconomic trends by buying and selling stocks, bonds, currencies and commodities, have struggled to beat other strategies since 2010 as managers such as Louis Moore Bacon cited central bank action as a factor distorting markets. Funds in the strategy on average returned a cumulative 4 percent in the past four years, while those across all strategies climbed 15 percent, according to data compiled by Bloomberg. 

Fund returns

The Tudor BVI Global fund climbed 14 percent last year, a person familiar with the matter said, and 6.3 percent in 2012. 

Tudor expects an increase in the federal funds target rate, now at a range of zero to 0.25 percent, in the summer of 2015, according to the note. Economists anticipate the gauge will rise to 0.5 percent at the end of that year's third quarter, according to the median forecast of 59 people in a Bloomberg survey. 

An improving U.S. economy is underpinning inflation, limiting firings and lifting consumers' moods, brightening the outlook for growth at the start of 2014. Policy makers began reducing monthly bond purchases by $10 billion in January to $75 billion, citing an improving job market. Still, Federal Reserve Bank of Chicago President Charles Evans, who has supported record stimulus, said Jan. 15 that the central bank's slowdown should be seen as a shift in emphasis toward keeping interest rates near zero for a longer time, partly because of still-low price pressures. 

Inflation may be the spark persuading the Bank of England to raise rates in the fourth quarter, according to the Tudor note. Bank of England Governor Mark Carney will change forward guidance next month, according to economists, as they forecast that unemployment will hit a key level far earlier than previously anticipated. More than 60 percent of respondents to Bloomberg's monthly survey said Carney will refine the policy when the BOE publishes its quarterly Inflation Report on Feb. 12. Almost one-third of economists said the jobless rate will fall to 7 percent in the first half of the year, a juncture that will require Carney to consider raising borrowing costs. 

New Zealand may increase interest rates in March because of "robust business surveys, rapid house price appreciation, strong output growth prospects and a surge in terms of trade," according to the Tudor note. Reserve Bank of New Zealand Governor Graeme Wheeler last month abandoned his earlier stance that policy tightening could wait, saying interest rates may need to rise to 4.75 percent by the first quarter of 2016 from a record-low 2.5 percent. 

Tudor anticipates a Norway rate increase in the second half of the year. 

 

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What Five Days of Trading Tell Us About 2014

What Five Days of Trading Tell Us About 2014
By Jim O’Neill Jan 14, 2014 
Bloomberg

Over the course of more than three decades in finance, I got into the habit each January of developing investment themes for the coming year. Some habits are hard to break, and even though investment strategy is no longer my day job, my mind has turned to the same task. Usually I come to a pretty strong view, one way or the other, about the year ahead. This year, things don’t look so clear.

To begin with, there’s an odd little thing called the five-day rule -- an unlikely guide, you’ll think, but one I came to value as an aid to confidence. The rule simply states that when the main U.S. stock-market indexes show a combined positive return after the first five days of trading, the year as a whole is very likely to be a good one; if the return after the first five days is negative, it’s a coin-toss whether the market will be up or down for the year.

Usually, stocks rise in the first five days -- as you’d expect, because over the long term they return about 8 percent to 9 percent a year. This year they didn’t rise, despite the consensus among market analysts that 2014 is going to be a good year.

Jose Ursua, a former colleague of mine at Goldman Sachs, has run these numbers all the way back to 1928. He finds that when stocks rallied during the first five days, there was a 75.4 percent chance of a rally for the year. For the period since 1950, the probability rises to 82.9 percent. Few rules in finance are as unambiguous as that. So when the first five days has been net positive for the Standard and Poor’s -- and I’m feeling bullish in any case -- I’m especially confident.

This year I’m still feeling pretty bullish, but the five-day rule is against me. U.S. stocks fell 0.5 percent -- nothing drastic, but down nonetheless. Over the whole period since 1928, a negative start implies a 47.8 percent chance of a negative year; since 1950, the figure’s about the same, 46.4 percent. In both cases, call it 50-50.

As I say, I’m in the bullish camp for the world economy in 2014. I’m expecting gains in the so-called developed economies and in a number of so-called emerging economies -- including some of my old friends the BRICs (Brazil, Russia, India, China) and some of my newer ones in the MINTs (Mexico, Indonesia, Nigeria and Turkey). I think there’s a decent chance that world gross domestic product growth will exceed 4 percent this year. And that would be good news for financial markets -- right?

Not necessarily. Stronger growth in the U.S. and other developed countries would be bad news for bond markets. In the future, they can’t depend on the Federal Reserve to press down so hard on interest rates with quantitative easing. Expect more “taper tantrums” in 2014. This could be quite a challenge not just for bond markets but also for financial markets more generally. I say this even though I think Janet Yellen’s Fed will go out of its way to pursue “dovish tapering,” in the hope of avoiding a 1994-type bond-market rout.
Here’s another complication. The U.S. trade deficit just dropped to its lowest since 2009, consistent with a current-account deficit of about 2 percent of GDP. This news was too little noticed: It shows that the post-crisis U.S. will be a different and better-balanced economy, refuting the idea that the U.S. would inevitably face a widening external deficit when it started to grow again.

But there’s a downside. A narrower external deficit could imply a diminished supply of global saving, and upward pressure on inflation-adjusted interest rates. You could see this, and even welcome it, as a necessary transition to more normal conditions -- but it adds to my concern about investments that might not get along with normalcy.

On top of all this, investors start 2014 with a perennial concern about the major currencies. Most seem to think the dollar is the least exposed -- for the reasons just mentioned -- and I go along with that. But I’m not as confident in this view as I’d like to be, partly because U.S. policy makers won’t want the dollar to rise too much.

A lot will depend on whether other economic leaders can step forward to support global activity as the U.S. strengthens. China, Germany, India and others are possible candidates. I’m convinced that a new and healthier Chinese economy is emerging. If others join in that assessment, the mood of global investors will lift appreciably. But will Germany act decisively on fears of euro-area deflation? Will India elect a government that can make effective decisions and turn that country’s vast potential into reality?

In all three cases, improvements in the credibility of economic policy could deliver excellent results both at home and in global terms. Those improvements are certainly achievable. I’d like to say I’m sure they will happen -- but hopeful is the best I can do. Happy New Year.

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