A surge of blockbuster takeovers and buyouts has provided renewed ammunition for the corporate bond market, supplying fresh kindling in what is already set to be a record year of debt issuance.
The backlog of M&A that had yet to be financed slid to $246B at the end of September from more than $900B in late 2015, according to BofA Merrill Lynch, but that figure has climbed 87% to $460B following the recent string of deal announcements.
For all the talk of Russia's economic woes, the corporate debt of that country has far outperformed that of the U.S. this year. Noting that, Deutsche Bank strategists Oleg Melentyev and Daniel Sorid suggest the tide of the U.S. corporate debt boom could be turning.
Helped by a flood of retail money into investment-grade bond funds, the size of the corporate debt market has risen to $7.8T from $5.4T in 2009, fueling a boom in buybacks and EPS in an otherwise middling economic environment.
The result is more levered corporate balance sheets (even stripping out oil companies) just at the time when the Fed is getting set to hike interest rates.
"As the Fed prepares the market for the end of the period of zero short-term rates, we may be approaching a reassessment of just how much leverage is appropriate given the overall market compensation," conclude the duo.
U.S. companies have issued a record $39B of bonds in 2015 that mature in more than three decades, more than five times the amount sold in the same period last year, according to data compiled by Bloomberg.
Oracle joined the fold this past Tuesday, selling $1.25B of securities due in 2055. Another notable is Microsoft, which sold its first 40-year bond in February.
Treasurers are embracing what may be their last opportunity to lock in cheap long-term funding costs before the Fed raises rates, while investors are snapping up the longer-dated securities because they offer a higher yield over shorter-term debt.
The iShares Interest Rate Hedged Corporate Bond ETF (LQDH) is an active ETF which will invest primarily in the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) while mitigating the fund's interest rate risk exposure.
The iShares Interest Rate Hedged High Yield Bond ETF (HYGH) is an active ETF which will invest primarily in the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) while mitigating the fund's interest rate risk exposure.
Two target maturity date ETFs will also launch on the 29th: the iSharesBond Dec 2016 Corporate Term ETF (IBDF) and the iSharesBond Dec 2018 Corporate Term ETF (IBDH).
Regional transmission organization PJM says its recent auction to procure power supplies for 2017-18 resulted in a clearing price for resources - which includes generation, annual demand response and energy efficiency - which rose to $120/MW-day for most of its deliverability area.
PJM, which coordinates the movement of wholesale electricity in all or parts of 13 states and D.C., says the auction continued an overall trend toward more gas-fired generation and increasing diversity of resources.
PPL, Exelon (EXC), American Electric Power (AEP), Duke Energy (DUK), Dominion Resources (D) and FirstEnergy (FE) are all up ~1% AH.
Earlier, Barclays downgraded the entire electric sector of the U.S. high-grade corporate bond market to underweight, saying it sees long-term challenges to electric utilities from solar energy which aren't yet priced in.
With borrowing costs about the lowest on record, and investors lending first and asking questions later, corporate finance officers are busy taking out loans. "My treasurer tells me always borrow when you can, not when you have to," says Shell CFO Simon Henry. "There are huge liquid pools at whatever tenor we need ... There's more capital out there than we can consume."
The average yield on corporate debt has fallen 61 basis points this year to 4.4%, nearing last year's pre-bond bear market low of 4.1%.
“The market is pretty hot,” says George Dessing, treasurer of Dutch business-to-business publisher Wolters Kluwer NV which raised 10-year money this month. “We have a preference for longer maturity and especially right now at these low costs it was a no-brainer.”
Maybe surprising to many, long-dated investment-grade corporate bonds are outperforming junk bonds this year, with total returns already of 7.48% vs. junk at 3.3%. It's a turnaround from 2013, when high-yield returned 7.42% vs. a loss of 1.57% for IG paper.
It's good news for institutional investors like pension funds and insurers, who have been big buyers of the bonds in recent months.
In other junk bond news, DoubleLine's Bonnie Baha says the firm's core fund has cut its high-yield exposure to 3% from 6%. High prices are the reason, says Baha, noting the average price of 104.5 cents on the dollar. Many issuers can force redemptions at 103 cents, and if they don't get called, in a low-rate environment there's extension risk.
Baha takes note of the proliferation of short-duration high-yield funds. "It's a fallacy to think that just because it’s short-term that bad things can’t happen."
"The good ole' days are gone," says UBS, cutting its recommendation for U.S. corporate bonds to "small underweight" ahead of what's expected to be the beginning of a rate hike cycle in about a year.
With spreads already so tight, any further gains from spread tightening will be marginal at best and not enough to make up for rate increases, says the team, which is bearish on both investment-grade and high-yield corporate debt.
Investment-grade corporate paper returned 2.7% in in Q1 vs. a 1.42% gain for the MSCI World Index of stocks, the first time debt beat equities since Q2 of 2012. This follows stock gains of 27% last year while bonds fell 1.45%, and a near-universal outlook at the start of the year to rotate out of fixed-income and into equity.
Junk bonds returned 2.86% in Q1.
Helping, of course, is the decline in benchmark Treasury yields, but corporate balance sheets have improved, with at least some of that related to the rollicking stock market narrowing pension fund deficits.
Eyeing better growth and sustained low interest rates, Moody's projects the global default rate to drop to 2.2% this year or 61 companies globally, from 2.9% or 66 companies in 2012.
"Additional factors that support our view of a low default rate in 2014 are the continuous accommodative monetary environment together with ample liquidity, which has and will continue to allow distressed companies to access the capital market and reduce refinancing risk in the near future."
For perspective, the average default rate since 1983 is 4.7%. It is indeed a golden age for corporate borrowers.
"The default rate is non-existent," he says, agreeing that fundamentals in high-yield look good. "Instead of a default cycle, we've had a refinance cycle." The issue, however, is valuation. At the end of 2013, the 30-year Treasury yielded about 4%, while BB corporates "unbelievably" yielded just 4.5% - a "remarkably low incremental yield."
His feelings about overvaluation extend to the investment grade corporate market (LQD) as well.
Most curious to Gundlach is how universally the long bond is hated at 4%, while junk yielding 4.5% gets so much love.
Besides Treasurys, Gundlach sees value in emerging market bonds. The risk is in the currency, but this can be eliminated by buying dollar-denominated paper.
Open for trade today is the ProShares Investment Grade Interest Rate Hedged ETF (IGHG) whose underlying index tries to achieve a duration of zero by offseting corporate debt holdings with a short position in Treasurys.
ProShares this summer launched a similarly hedged fund, but one aimed at high yield, the ProShares HighYield Interest Rate Hedged ETF (HYHG).