Month: February 2016

One of the big problems with the artificial equity rally of the past 7 years is that virtually all of its has come on the heels of a historic splurge in stock buybacks: after all even Goldman recently admitted that buybacks have been the sole source of stock buying in recent years.

This in itself would not be so troubling if it weren’t for the source of funds used to finance these relentless stock repurchases. Amazingly, if one nets out all other sources and uses of S&P500 corporate cash, virtually every dollar in buybacks has been funded by a dollar of new debt, as Socgen showed several months ago.

 

To frequent readers, none of this should come as a surprise: we warned about not only the arrival of the buyback bonanza as long ago as 2012, but that the endgame would one that ends in tears for everyone involved.

Now, many years later, the mainstream media is catching up.

In a piece overnight, the WSJ writes that “low rates alone aren’t enough to make it easy to pay off a loan. Many companies may find that out the hard way, especially as high-yield debt markets show signs of strain lately.”

U.S. companies went on a borrowing binge in recent years. Nonfinancial corporations owed $8 trillion in debt in last year’s third quarter, according to the Federal Reserve, up from $6.6 trillion three years earlier. As a share of gross value added – a proxy for companies’ combined output – corporate debt is approaching levels hit in the financial crisis’s aftermath.

Actually corporate debt has long since surpassed levels hit in the financial crisis’s aftermath as we first showed months ago:

What the WSJ does get right, however, is the big picture:

Because those stock buybacks helped reduce companies’ total shares outstanding, earnings per share got a boost. Indeed, absent the past three years’ share-count reductions, S&P 500 earnings per share would have been 2% lower in the fourth quarter than what companies are reporting, according to S&P Dow Jones Indices.

What it also gets right is something else we warned about back in April 2012, namely that in the age of ZIRP, when hurdle rates are non-existent, the best capital allocation option for CFOs is shareholder friendly activity such as M&A, dividends and of course, buybacks, especially if their own equity-linked compensation rises as a result:

The major reason companies plowed money into buybacks rather than capital spending was that, in a low-growth environment, the returns from investing in expansion didn’t seem as attractive as in the past. This is a big part of why companies were able to borrow cheaply: In a low-growth, low-inflation environment, investors were willing to accept lower returns on corporate bonds than if the economy was moving at a more rapid clip.

The rest is history: “most of the debt increase came from bond issuance, as nonfinancial companies took advantage of the lowest rates on corporate bonds since the mid-1960s. That is a plus as companies in many cases extended the maturity of their debt and lowered borrowing costs.”

The negative: Rather than investing the funds they raised back into their businesses, companies in many cases bought back stock instead. That was something that many investors welcomed, but it may have come with future costs that they didn’t fully appreciate.”

Again, a mistake, because it was not “in many cases”: it was in all cases. See the first chart again if confused.

But what is more important is that the WSJ correctly hints at what the real issue now that the buyback binge is over and the time to pay the piper has arrived, especially in a rising rate environment:

The sticking point is that in a low-growth environment, paying down debt also may be harder. Especially because companies weren’t putting the money they borrowed into capital investments, which provide cash flows to help service debt. The stock they bought back won’t do that for them. Even if this doesn’t present an immediate problem for all companies given how they refinanced debt to longer maturities, it could be a long-term drag on earnings.

Actually, it is a problem… or rather two.

In a report earlier today, Bloomberg looked at the biggest hangover from this epic debt issuance spree, and found the first big problem, or rather first 9.5 trillion problems: that is how much debt the corporate buyback binge will cost companies over the next 5 years as the debt matures. And clearly, since corporations do not have access to this much funds, they will have to roll it over and refinance it.

As Bloomberg writes, this wave of debt coming due through 2020 is bigger than previous five-year schedules of debt maturities in 2013, 2014 and 2015, according to Standard & Poor’s data. It includes about $2.3 trillion of junk-rated debt, with about $418 billion of that rated B- or lower. And it peaks in 2020, with $2.1 trillion of debt coming due, which is greater than the peaks of the most recent previous maturity walls.

U.S. companies account for $4.1 trillion of the debt coming due through 2020, while European issuers are responsible for $3.7 trillion, S&P data show. More than half of all the debt coming due belongs to nonfinancial corporations.

The real issue, however is the near-term maturities, of which there are $1.8 trillion in 2016 alone, of which $570 billion are US-based Investment Grade maturities.

Bloomberg also hints at the second big problem, one which we discussed extensively at the end of 2015 following the first debt fund gates and liquidations, and especially one week ago when we documented the collapse of the CLO bid: the disappearance of virtually all demand from the primary bond market, most certainly in the junk space, and gradually, in investment grade as well.

If investors don’t return to their carefree ways of lending, global companies will be in for a rude shock. All that money that came so cheaply in the recent past will actually have to be paid back at some point. It’s not just a merry-go-round of lending. The buck must eventually stop with them.

Alas, as Citi’s Stephen Antzcak showed in a report released late yesterday, investors are not coming back “to their carefree ways of lending.” Quite the opposite.

Here are the big picture bullet points:

• Overview — So far this year the volume of primary market activity has deviated from consensus expectations. But there were bigger surprises, in our view, including the extent to which IG primary market activity has been sensitive to volatility.
• Skittishness in the IG Primary Market – The IG primary market saw roughly 75 no-go days over the past 12 months. This looks worse than even the ’08-’09 episode. There’s a lot of paper that “must” print in the period ahead…where will it price if we’re in a stretch of “no go” days?
• VIP Only Access in HY – HY activity has slowed to a drip, and it seems only the best-in-class HY names are able to garner interest. Will more issuers gain access as volatility ebbs?
• Similar Story in Leveraged Loans – Leveraged loan supply has sputtered overall, and most of the supply has been “event-driven.” As in HY, will we see issuers regain access to loan financing?

Odd: it is “skittishness” when there are no bid in the primary market; did Citi call it “stupidity” or “serenity” when Petrobras 100 year bonds were 5x oversubscribed last June, leading to unprecedented losses just a few months later? In any case, here are the details:

First, investors seem to be more skittish than usual with regard to the primary market, and the primary market responds quickly and dramatically when volatility rises. As noted above, this was evident in the IG market earlier this month when we saw 6 consecutive days with absolutely no new supply. There is a large pipeline of IG deals that “need” to come in the period ahead, and more stretches of no-go days could force issuers to capitulate and price their deals wider than anticipated. This would obviously re-price secondaries.

 

Second, this investor skittishness has spread from the trouble spots (i.e., energy and basics) to the broader market, particularly in HY and loans. This may not be a problem yet as companies have termed out liabilities (Figure 3, Figure 4), but the extent of access certainly bears monitoring.

Yes, many companies do have termed out liabilities, except for those who have $1.75 trillion maturing in the next 10 months.

Meanwhile, there is a clear buyer’s strike which despite the S&P500 being less than 10% off its all time highs, continues with only sporadic intermissions:

it is not just junk bonds where the buyers are stepping away: it is increasingly investment grade, where if one excludes the AB InBev mega deal things are rapidly slowing down. Here is Citi:

On the surface at least, it appears that the IG new issue market has been chugging along at a relatively healthy clip, albeit with higher new issue concessions. By Feb 25th, we’ve already seen $200bn of new deals come to market – that’s 14% ahead of the pace set over the same period in ’15, which was a record breaking year in its own right. With that said, one could make the case that it’s the InBev M&A-driven megadeal that drove the growth in supply (issuance ex-ABIBB is 12% lower YoY).

 

To our minds though, it’s the increased irregularity of the new issue flows that’s concerning, particularly since we may have something on the order of $570bn of maturities to get refinanced by year-end. Throw in the M&A pipeline, and it’s a large number to push through a stop-and-go primary market.

But for the real horror, look nowhere else than the junk bond space:

Across credit, it’s the HY supply that took the biggest turn over the last 12 months. So far this year HY supply is down ~75% compared to this point last year. Only a meager $12bn via 21 deals were completed, which are basically Lehman-era levels (Figure 7). Aside from the headline volumes though, there are a few other concerning features of the recent supply:

• Extraordinarily concentrated use of proceeds: HY issuance this year is almost entirely attributable to M&A, an activity that is very visible and generally has a set timeline. Very little supply is attributable to any other use of proceeds (Figure 8). Again, this may not be a major problem in the near-term, but obviously will be as time passes and if conditions don’t change.

• High-quality wanted: What’s more, HY supply so far this year is comprised predominantly of just two major deals (32% of YTD supply). Importantly, they are both higher quality HY names from the less troubled sectors (healthcare and technology, respectively).
• Contagion through supply? It’s no surprise that primary issuance exhibits a correlation to secondary market volatility, as both share broader HY risk appetite as a driving factor. Indeed, Figure 9 shows that issuance fell by mid ’15 when there was demonstrably more trading volatility.  What’s worth noting, though, is that issuance hasn’t just pared back in the corners of the market where risks were most apparent (i.e., commodities), but rather broadly across even the “safer” sectors.

Here is the best visual of the total carnage in the primary junk bond market:

Keep in mind that hundreds of billions in junk bonds are coming due over the few years in the US alone: absent this freeze in the primary issuance market thawing fast, bond yields will continue rising in a feedback loop, forcing management teams to issue debt with draconian terms, as they scramble to find any buyers.

To be sure, there is demand, but one has to pay handsomely for it, case in point Solera, which as we reported last week, is the subject of one of last year’s largest leveraged buyouts, has been struggling to raise money even with Goldman as underwriter.

There was some good news moments ago, however, when the bond issue for the LBO finally priced. The bad news: it did was at a whopping 11.5% yield…

• PRICED: SOLERA $1.73B 8NC3 AT 95 TO YIELD 11.47%

… effectively repricing the entire junk bond market between 50% and 100% higher.

Which is, ironically enough, not the worst news – as Citi notes, only a select few “VIP” companies will be able to refinance regardless of the yield; for most other companies, the refi market sill simply stay shut and the upcoming maturities will lead straight to bankruptcy, without passing go.

The only possible bailout? A full and unconditional Fed relent, with Yellen going back to square one, not just lowering rates, but also unleashing more QE. Because as we have said since day one, ever since the last crisis, absolutely nothing has been fixed and instead constant Fed intervention merely allowed the can to be kicked.

And now the market is about have a rude awakening confirming just this, at which point it will have only one option: crash the market, and force Yellen out of her shell, unleashing another massive Fed easing program.

At that moment the ball will be in Yellen’s corner and her choice will be simple: will she go down in Fed history as simply the Chairman who was wrong, and was “forced” to abort the Fed’s first rate hike cycle in nearly a decade, or will she go down not only in history, but also in flames, and take the so-called market, Keynesian economics and monetary theory, as well as the entire U.S. economy, down with her?

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Submitted by Martin Armstrong via ArmstrongEconomics.com,

I do not advise Trump. If he demonstrated that we need major reform because we are going broke under the management of career politicians, then he might attract more people who are on the fence. Let’s be realistic. Those supporting Trump distrust government politicians. They really do not care about his message. I at least would prefer Trump not for any policy, but any career politician will bring the same line of thinking to the table. There will be no thinking out of the box and we will be blasted with more regulation and taxes killing the economy. They will continue to hunt money until nothing is left for us but total enslavement and that does not matter if we are talking about Rubio or Hillary.

Obama stuffed Christine Lagarde into The IMF and that has been far more devastating than any appointment to the Supreme Court. She has destroyed the global economy threatening countries to hand over info on everyone (except exempt politicians like her of course) so they can hunt money absolutely everywhere. They do not look at the net result, and only look at the world through their own greedy eyes. I would hope Trump would look at this as a businessman and say; you people are nuts.

The standard of living for families is declining. That is not because the “rich” are making more from investment, it is because of rising taxes and government robbing their savings to fund themselves and pretending they are there for their retirement. In reality, they keep lowering benefits because they stole all the money. Anyone in the private sector who did this would be in jail. We are prosecuted for fraud in the private sector, but fraud in public sector is rewarded and called “politics.”

What advice I would give Trump:

1. We will not raise the minimum wage, we will eliminate payroll taxes and end the borrowing from the poor robbing them of interest by handing them a refund check so they think politicians are fantastic
2. Instead of QE for bankers, eliminate taxes and try QE for the people
3. Eliminate Social Security for those under 50. Pay out those over 50. Replace Social Security with mandatory 401K investment plans
4. Merge SEC & CFTC so advisers can provide advice on the best investment rather than just what they have a license for in equities v futures
5. Eliminate domestic corporate taxation. This will provide the incentive to bring jobs home
6. Stop government borrowing. Limit the creation of new money to 5% of GDP (I do not want to hear that will be inflationary since QE failed to produce inflation which is all about confidence not the quantity of money). At times up to 70% of the national debt has been accumulated interest.
7. Retire the national debt and stop borrowing federally competing with the private sector for capital
8. Return the central bank to the original design of 1913. Eliminating government debt will do the job. During economic declines, the Fed should buy corporate short-term paper with its “elastic money” which will compensate for banks when they stop lending. Short-term corporate paper is actually paid off and that would then contract the money supply back to its original state prior to the crisis.
9. Judicial reform is mandatory. I would retire ALL federal judges. Replacements should be nominated only by the legal profession with penalty to bribe and such appoint to be life imprisonment or death, the choice is that of the sentenced person.
10. Expand the Supreme Court and make it an ABSOLUTE right to be heard rather than winning a lottery. Moreover, a panel of judges nominated by the legal community shall determine the constitutionality of ALL legislation BEFORE enacted. It should never be the burden of the citizen to PROVE the government is acting unconstitutionally. The Constitution is NEGATIVE and was intended to be a “restraint” upon government. ALL LIVES matter; do this and they will.
11. Reform the Grand Jury process. Both sides should be allowed to present ALL evidence to the Grand Jury and they alone will decide to indict. State prosecutors who protect police should themselves be in prison.
12. Restitution of the Roman position of Tribune of the people; a person who prosecutes any government employee from police up to judges and politicians. Then and only then will the system be cleaned out.
13. Eliminate TSA at airports. You should be cleared as to who you are and no need for Xrays and strip searches if you are known to be a normal citizen. If you are a foreign visitor, they alone should go through TSA if they do not have prior clearance.
14. Eliminate all taxes whatsoever if you are not present to use such services.
15. End all government pension plans which they never fund properly any how. Eliminating taxes will allow greater savings and they should be required to save a portion as do private citizens.
16. Forgive all student loans and end subsidization for college. Without competition, the education is worthless anyhow. Restore the Roman system of apprenticeship. In Switzerland, less than 10% of students go to college. They enter an apprenticeship in the field they desire. Being taught by the real world is far better than theory.
17. Reform lawsuits capping jury awards and this will reduce medical costs. Introduce Artificial Intelligence systems which will provide the first diagnosis which will be far more reliable. Hospitals are turning into businesses of big corporates reducing family doctors. Eliminating medical expenses as a liability so they cannot take someone’s home or put them into bankruptcy (opposite of Clintons did to students) will cause the healthcare to be a normal business cycle rather than an extortion that is like government consuming a larger proportion of disposable income. Return hospitals to their Hippocratic Oath and must FIRST take care of anyone irrespective of money: hence, end Obamacare.
18. Eliminate all property taxes. You should be able to retire without having to cope with rising property taxes.
19. No person should have to pay more than 15% of their salary to state and local government. If a government needs more, something is wrong and they need to be reformed.
20. All government pensions must be eliminated. Part of the QE process should be the bailout of pension systems for government workers and end the process. If we eliminate taxation and social security, they will by law be required to save a portion in their own 401K

These are just for the start. This is my short-list I would advise Trump to adopt. Then he just might beat everyone in history with the percentage of the popular vote exceeding 65%.

via Zero Hedge http://ift.tt/21xsmnm Tyler Durden

The trend we flagged in November of 2014 continues unabated.

When the Saudis moved to artificially suppress crude prices in an effort to preserve market share by bankrupting the cash flow negative US shale space, Riyadh was gambling.

Gambling on how long US producers could rely on wide open capital markets to keep them afloat. Gambling on how tolerant everyday Saudis would be should it become necessary to cut subsidies to shore up the budget. Gambling on the extent to which the market would test the riyal peg. And on and on.

In short, the kingdom was betting that it could ride out the price storm without essentially going bankrupt. But the downturn has lasted longer than the Saudis might have expected, and now that some 1,000,000 b/d of Iranian supply is set to come back online by year end, Riyadh has to a certain extent lost its ability to control the situation.

Complicating matters is the war in Yemen, which next month will drag into its second year. Not only has the conflict been costly, it’s also put Riyadh in a bad spot from a reputational perspective. Last week, the European Parliament recommended a wholesale embargo on arms sales to the Saudis in light of the 3,000 civilians the kingdom has “accidentally” killed over the course of the campaign to rout the Iran-backed Houthis. 

All of this costs money. Lots of it. The war, the 16% budget deficit, maintaining the riyal peg – it’s all costly and it’s showing up in the depletion of Saudi reserves which in January fell 2.4%, or $14.3 billion, falling below $600 billion for the first time since the summer of 2012. 

Last month was the third month in a row that the SAMA reserve drawdown topped $10 billion.

Why should you care? Well, that depends on who you are. For markets, this is a perpetual liquidity drain. The Saudis are no longer net exporters of capital, which means the country is noa drag on global liquidity rather than a boon. That’s a fancy way of saying this: the SAMA drain is just QE in reverse. When SAMA falls, it amounts to monetary tightening. The same is true of selling by other SWFs which, as we documented earlier this month, may be set to extract up to a half trillion from global equity markets in 2016.

Here’s a look at the drawdown and as you can see, this is getting serious – fast.

It may appear as though that stash will hold up, but just like Beijing, Riyadh is going to discover that these reserves evaporate rather quickly in times of stress. 

Don’t be surprised when the chart shown above goes parabolic – in the wrong direction. And at that point it will be do or die time. Either cut production and rescue the budget and ditch the riyal peg, or go broke. Stay tuned, because this year’s red ink is projected at 13% – and that’s assuming there’s no intervention in Syria.

via Zero Hedge http://ift.tt/1OJv2Sj Tyler Durden

Submitted by Eugen von Bohm-Bawerk via Bawerk.net,

In a recent article by Kessler Companies (hat tip Zerohedge) they correctly point out that inflation, as measured by the consumer price index, have a tendency to accelerate as the US economy moves into a recession.

Contrary to popular belief, the beginning of a recession is not deflationary but the exact opposite. As can be seen from the chart, consumer prices do indeed move higher into recessions as represented by the shaded areas.

Why? The most obvious explanation is simply that the Federal Reserve is forced to act, as the CPI signal (or more accurately the PCE) trigger rate hikes. This increases borrowing costs and disrupts the established money flow forcing the economic system to reallocate resources accordingly. As households home equity lines dries up, there will be less spending on, say, restaurants which concomitantly changes relative prices – wages for waiters fall relative to other wages – and resources then start to flow into other parts of the economy seeking profits where they are easier to achieve. Needless to say this process takes time and is commonly known as a recession.

The obvious correlation between effective federal funds rates and the CPI substantiates our claim. The real federal funds rate or the spread between “core” CPI and the federal funds rate brings the point home.

Prior to every recession the real federal funds rate moves higher (more negative in the chart) and then make an abrupt about-turn as the Federal Reserve realize they have moved too far as the process becomes deflationary.  It is also highly noteworthy that since the GFC the real federal funds rate have been negative for an unprecedented amount of time. Compare that to the brief period of negative real yields prior to the GFC and what that lead to and you quickly realize how much economic malinvestments and dislocations are present in the system.  

If we are going with the current forecast by the Federal Reserve staff the implied real federal funds rate will go from unprecedented negative to strongly positive in short order. It is also highly concerning that the calculated sustainable rate of interest given federal debt levels and assumed nominal GDP growth falls below the expected path of the federal funds rate. In other words, as the Federal Reserve intend to move us away from ZIRP with the rest of the world rushing headlong into NIRP (good luck with that) we are bound to bump against the recession ceiling. It has happened every time they tried it before.  

In addition, the tightening cycle is actually far more mature than the tiny hike in December would have you think. Wu and Xia’s “shadow rate” tries to estimate the effect forward guidance and various QE and MEPs have had on financial conditions and from that provide what the actual rate is. By their estimate the tightening cycle started already back in May of 2014.

This is all well and good, but what caught our eyes when looking at the Kessler chart recreated above was the increasing spread between “core” CPI and PCE as the economy entered into a recessions. The CPI historically starts to accelerate into a recession while the PCE seems to lag behind. The spread between the two widens into recessions and then comes back down and stabilizes after the recession.

The main difference between the “core” CPI and PCE is the weight allocated to shelter. The CPI is far more sensitive to changes in cost of shelter, as the index allocates over 40 per cent to housing, than what the PCE index is.

Housing is obviously very interest rate sensitive and thus easier for monetary authorities to manipulate than many other goods that enter into the CPI basket. A look at the housing component reveals the same pattern. Housing costs, either through increased price of houses or higher rent for shelter in general tend to accelerate higher as we move into recessions. With housing cost driving up CPI, the Federal Reserve hike rates and pull the rug under a very interest rate sensitive sector of the economy.

Housing starts drop as higher interest rate reduces affordability and increases debt servicing cost (which put pressure on discretionary spending) and then regain traction as the Federal Reserve start to ease into the recession as household’s affordability improve. 

At today’s level US household’s debt servicing cost are at record low levels, while their overall debt is close to record high. This is obviously a function of extremely low rates of interests. However, if, and that is a big if, the Federal Reserve hikes rates, an indebted household sector will rapidly come under pressure, just like the high yield energy space already has.

After tightening policy since 2014 with a consequent shift in the US dollar, financial stress is already at very elevated levels and further monetary policy divergence with the rest of the world will only exacerbate this unfortunate development.

Bottom line is simply that the probability of recession is increasing.

As we outlined here on several occasions in 2015, we expect a recession by the end of 2016, and if that projection turns out to be wrong due to a massive turnaround in Fed policy, the cataclysmic event will only be postponed till 2017.

via Zero Hedge http://ift.tt/1Qo1DCO Tyler Durden

Donald Trump is causing quite the ruckus in American politics.

What started as a parody campaign has now, nine months later, mushroomed into a legitimate bid for the White House. That’s upsetting to the political establishment on both sides of the aisle and now, both the media and America’s entrenched political establishment are struggling to come to terms with the brzen billionaire’s success.

Last week, in what some view as a prelude to a fascist future for America, Trump suggested he would change libel laws in order to give himself greatere scope to sue journalists who pen negative articles about him. But as you’ll see from the clip shown below, it may be more efficient to just “choke slam” some folks. 

                                                                                                                                       

The reporter, one Christopher Morris, appears to reach for the throat of a secret service agent in one of the clips. “I never touched him,” Morris says, in what is frankly, a lie.

Still, it’s a bit disconcerting. We would ask: Is this a preview of what’s in store for America’s press?

Here’s the official word from the Secret Service:

Secret Service statement on the altercation today with a photographer. http://pic.twitter.com/nRql6nV1tJ

— Olivier Knox (@OKnox) February 29, 2016

Secret Service agent choke slams reporter http://pic.twitter.com/jdsHOlylSB

— Joe Perticone (@JoePerticone) February 29, 2016

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