In early March, investors celebrated the seven-year anniversary of the S&P 500 market bottom following the crash of 2009. After seven years of a strong recovery, 2016 has signaled a change in market trends as volatility increases and numerous global economies begin to feel the repercussions of changes in growth estimates. These past few months have been extremely difficult for global investors as major headlines featuring low oil, slower growth in China, and the looming "Brexit" impact investor sentiment. In the face of these global pressures, investors had hoped that the start of 2016 would mark a change in momentum, however this did not occur as in a matter of three weeks the market selloff had wiped out $15 trillion in investor capital. This poor start to a new trading year greatly impacted the outlook for the US economy and global allies as growth estimates were revised and investors began to price in a higher risk premium. Four months later and these signals of fear continue to wear on the global economy as oil remains low and volatility continues to frighten investors. In the face of this uncertainty and the market's recently celebrated anniversary, it is important to consider how much longer this US bull market will last. Making such a prediction is difficult, however, for fundamental investors such as myself the strategy in maneuvering current markets is to ignore the headlines and focus on the numbers. Part of this strategy is to analyze institutional confidence in the bond market to determine how strong demand is for debt - an indicator of how confident companies are in future growth.
In the last month, Apple (NASDAQ:AAPL) returned to the debt markets to raise capital for their corporate strategy and the results provided an interesting illustration of the current risk tolerance bond holders are willing to accept. The strategy behind this debt raise was rather simple to take advantage of lower interest rates in order to focus on stimulating growth in key markets. While from a strategy perspective the debt raise was welcoming to shareholders, the cost of debt at which Apple raised the $12 billion provides an interesting perspective on the risk premium investors are currently pricing in. Delving into the numbers and comparing this year's cost of debt to previous years, readers are able to quantify the relative change in risk seen in the market as Apple does provide a rather good representation of the current US economy and public markets. To further elaborate on this statement, based upon a correlation analysis, Apple's share price to the price of the Nasdaq generates a one-year correlation coefficient of 0.83 and a five-year coefficient of 0.92 which indicates a strong relationship in share price appreciation/depreciation.
Sourced from Yahoo Finance
In order to conduct this analysis, I used Apple's record breaking $17 billion corporate bond sale in 2013 as a benchmark. During this time, rumors of Apple's China Mobile deal in addition to high oil prices were driving North American markets higher which helped increase demand for their upcoming bond sale. Conversely, in the current market, with low commodity prices and underperforming economic indicators, the two periods remain vastly different in economic strength and structure. This comparison provides two parallels which can quantify how the risk levels in US markets have changed in the past few years.
Before making any conclusions, it is important to evaluate if the company has fundamentally changed since 2013 which could interfere with any conclusions drawn from this comparison. One of the main reasons why risk levels increase and impact a company's interest rate is due to changes in a company's financial leverage or short-term liquidity. In this example, Apple has one of the most solvent and stable balance sheets in the world with a growing cash account and additional reserves held for tax purposes in the long-term marketable securities account. In Q1 of 2016, Apple had in excess of $253.88 billion of cash and equivalents on hand, which has increased by $85 billion over the past three years. Looking at the chart below, the strength of the company's balance sheet has actually improved over the past three years making it an even more stable company from a creditor's perspective.
Author's Own Work
With the largest market cap in the world and one of the most recognized brands in history, Apple is arguably one of the most stable companies in the world and warrants a favorable variable rate on its shorter-term debt. In a rational market, this stability and financial strength would equate to Apple issuing short-term debt at near LIBOR rates, also known as the average interbank interest rate at which chartered banks are prepared to lend to each other. When considering the overall position of the company relative to other sectors, the financial scale and stability of Apple ensure that the default rate on all short- and long-term debt is lower than the market average. With this being said, the 2013 debt raise illustrated this strength as the company's financial strength was rewarded by the market and Apple was able to raise $1 billion at LIBOR plus 5 basis points. The success of this debt raise indicated that the market considered the company almost as financially stable as a chartered bank. Comparing this to Apple's 2016 debt issuance, the company has been priced much differently as the different tranches in Apple's debt offering indicate large changes in its cost of debt:
Author's Own Work
Looking at the first tranche, the three-year floating rate bond is the noticeable difference with a dramatic 1540% change in the coupon rate since 2013. In addition, the five-year floating coupon rate saw a 352% increase while the fixed three- and five-year tranches saw expansions of 188.9% and 125%, respectively. While debt markets have suffered in the past few months, this large increase in the coupon rate for Apple's debt offering signals a possible longer-term conclusion impacting the general market's outlook. While the amount of debt raised was almost $5 billion more in 2013, the cost of debt increased at an unusual rate which signals that current investors have begun to reconsider the strength of the company. As previously mentioned, while the fundamental strength of the company is much stronger in 2016, it seems that the decline in overall confidence has impacted even the strongest companies.
Author's Own Work
When illustrating the growth of the coupon rates for each tranche, the changes are more prevalent for shorter-term bonds which indicates that the market has significantly changed its perspective for growth in the short term. When considering such a large company like Apple with its $253 billion in cash reserves, the size of the enterprise and its large global market share support the correlation between the share price performance and the change of sentiment in global markets.
For general investors, it remains difficult to evaluate the large amount of economic data in order to illustrate and understand the relative strength of global markets. While index funds match the movement of domestic economies, international enterprises of Apple's scale and caliber offer the ideal method to follow global markets and determine how confident investors are. For this reason, when such a large company enters the debt market and asks institutional investors for additional funds, the bond market is much more responsive to changes in investor sentiment. When interpreting Apple's recent debt raise, the increase in coupon rates provides a great indicator for how sentiment in the global economy has changed over the past few years. The three- and five-year floating rate bonds have seen a dramatic increase in interest rates and this is clearly driven by the response of debt markets to increased risk. While the company itself has not seen a decline in financial strength or growth opportunities, the market has indirectly illustrated the change in growth sentiment through Apple's return to debt markets. Therefore, in the past three years, while the US market has been praised for its global strength, the relative outlook for the economy has changed. In the current market, investors have begun to price all assets, regardless of fundamental strength, at a higher risk premium which shows that the outlook for 2019 (expiration of short-term maturities) remains much poorer than previous market estimates.
^Sourced from the Bureau of Labor Statistics
After considering the relative risk Apple bondholders are willing to accept, it seems that the confidence level in the market has taken a significant hit in the past year. While many investors have pinned the decline in confidence on the lower price of oil and lower growth in China, another possible consideration is that the market has become less optimistic of US growth prospects. A majority of the recent bullish sentiment has been driven by strong non-farm employment numbers and quarterly GDP growth. However when consulting the longer-term charts of these respective statistics, both indicators have been relatively flat in the past few years. Therefore, in the current market, growth expectations have been driven by more short-term oriented statistics rather than longer-term trends in the economy, a problem which ignores the fundamentals of sustainable growth. When considering Apple's return to the debt markets, the company's higher variable rate signals that the risk premium for the company has increased. The correlation of the company's strength to the performance of global markets signals that with this higher risk premium, the general market has changed its expectations of where the economy will be in the following three years. In the current market, this conclusion can help us numerically illustrate how market confidence has changed in the past few years as the US economy enters its seventh year following the market bottom of the 2009 financial collapse. While it remains difficult to accurately project market performance, based on this increased risk level and weaker outlook for the global economy, investors expect that markets in the medium term will return much lower annual growth rates than in previous years.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.