The Night of the Living Debt

by: David Goldman

The most remarkable data point in corporate valuation is this:

Graph of BofAML US Corporate BBB Effective Yield

Baa/BBB borrowers are paying barely over 4% for corporate debt. That’s roughly the growth rate of nominal GDP, figuring 2% real growth and a little over 2% inflation. With risk priced extremely low (or not priced at all), that’s the “natural” rate of interest: the average business should earn the GDP growth rate, so the cost of capital (before risk adjustment) should be roughly the GDP growth rate).

Given that the economy will suck wind indefinitely (with growth at an imperceptible 2% or so), who benefits? The answer is: corporations that can borrow for nothing and overcharge for products. By definition these are large caps, with strong credit and enough market share to maintain pricing power against deflationary headwinds.

By “overcharge,” I mean collect monopoly rents–whether by actual monopoly (as in Third World telecoms), or monopoly of skill, or whatever. Who might fit that description?

1) Telephone companies that can stand up to competitive challenges. TMX (Telmex) is the world’s nastiest monopoly (it costs several times as much to make a telephone call in Mexico than in Hong Kong, which is why the world’s richest man hails from a poor country). Will it stand up to political pressure? It always has. AT&T (NYSE:T) and Verizon (NYSE:VZ) are in the toy business (peddling Iphones and Ipads), and that’s though to predict. Chunghwa Telecom (NYSE:CHT) in Taiwan was the best performer in my portfolio this year (I just sold my position after a 40% gain); the Israeli cell phone companies have been a disappointment, beaten up by new market entrants. If a telephone service provider can keep any sort of pricing power, it is ideally situated to take advantage of extremely cheap capital. Which ones will survive? Not my department. Ask your friendly telecom analyst. I just bought a bit of PTNR and TMX after selling Chunghwa, enough to keep my eye on the sector. Having gotten lucky with CHT, I’m cautious about soon-to-be ex-monopolies.

2) Utilities and pipelines companies. With dividends where they are, a great alternative to bonds. I just liquidated some bonds and substituted the usual suspects in this field.

3) Defense contractors. Not a lot of competition to Lockheed Martin (NYSE:LMT) and Raytheon (NYSE:RTN), and I don’t believe the world is ready to do without their special brand of magic quite yet; I just bought LMT for the first time.

4) Drug companies. That’s too much of a crap shoot for me, and I own very small positions, enough to keep my eye on the sector but not enough to make a real difference one way or another. Those monopolies rise and fall too fast for me to monitor them.

5) Big miners. Just added Southern Copper (NYSE:SCCO) on the dip. And integrated oil companies. Marathon Oil (NYSE:MRO) has done wonderfully and I’ve been adding to positions.

6) Chip makers with a monopoly of skill. Beyond my capacity to judge, but Intel (NASDAQ:INTC) looked cheap enough on the recent dip to buy.

7) Chemicals and fertilizer. Added to Dupont (DD) and Terra Nitrogen (NYSE:TNH).

These are modest additions to my personal account, to be sure, not a long-short equity strategy, and I lean to the conservative side. And that’s not what equity investors are supposed to do: They are supposed to find the next Apple (NASDAQ:AAPL) (which turned out to be the last Apple). But with no next-new-thing on the horizon and little of interest in the venture capital pipeline, we’re stuck with looking at the liability side of the balance sheet. It’s a miserable existence, but better than throwing darts at the financial page.