Give me one moment in time….
The last week has brought new stories with familiar themes. Investors flirt with hubris, whilst occasionally looking down as the first rise in interest rates approaches. Economic news veers between the so-so, good and almost too good. Participants looking to the future and the past find cautionary notes, but there’s still plenty to rejoice in the now. It is a very particular moment in time for capital markets – one where so much is possible before what could be a more sober 2015. Banks approaching stress tests, PE investors looking for the exit, sovereigns covering 2014 and companies wanting cash to invest or buy or assuage shareholders – it’s their time.
Give me an A…and a buyback
The recent financial crisis chipped away again at the number of AAA ratings, taking the figure down to just three US non-financial companies. However, in today’s markets, the low number of AAAs is a question not just of ability, but also desire. There is such little kudos or advantage left in triple-AAA. The distinction between AAA and AA, in particular, seems rather abstract, with yields so low and traditional investors fishing for returns in murkier pools. Markets are certainly making little distinction. According to the Wall Street Journal, “AAA” Microsoft recently sold $450m five-year bonds at 0.32% over Treasury notes against “AA” Apple’s $4bn five-year bonds at a 0.40% premium.
If companies can see more profit in borrowing than conservatism, shareholders can too. There is an increasing trend for companies to “optimize their capital structure” in order to boost shareholder returns. S&P figures show companies have raised at least $11bn worth of debt so far in 2014 for this purpose, compared with $19bn in 2013.
This sea change helps to explain the shift in relationship between borrowing and investing and hence the low investment patterns we’ve seen in the recovery. Today’s corporate investment decisions depend less on earnings or credit conditions, than on management convincing shareholders of the case to leave money in.
Buybacks could also be putting management in a bind. They’ve been a key driver behind rises in US earnings, pleasing shareholders – especially the more active ones – but this is hard to repeat ad infinitum. Boards may need to reassert their role as being long-term creators of shareholder value, as opposed to short-term generators of shareholder returns.
Last week US leverage loan funds saw their third consecutive week of outflows following 95 weeks of inflows. To paraphrase Lady Bracknell, to lose one week might be regarded as a hiccup, to lose three seems rather more significant – particularly as investors removed $664m last week, the biggest withdrawal since August 2011. Inflows into European loan funds have also slowed.
There are possible explanations for the flight, although it would be hasty to discount herd mentality. Interest rate expectations do nominally drive loan funds’ popularity, since their floating rates returns offer protection against rising rates. A dovish Fed tone may be coaxing investors back into bonds and equities. Investors may be pushing back on a fizzy loan market. According to Bloomberg, around 20% of borrowers have been forced to offer higher interest rates since the beginning of March, compared with fewer than 9% during the first two months of the year. Either way, it’s the first test for the US loan market for a while and arguably a timely reminder that effortless money raising isn’t here forever.
Down, down, deeper and down….Eurozone inflation
The ability of Portugal and Ireland to exit cleanly from their bailouts is testament to their hard work and, it has to be said, a yield hunger that has allowed investors to focus on the positives and ignore the lack of defined banking and governance structure for Eurozone 2.0…2.1…3.0….
No one can deny that Portugal’s makeover has been truly remarkable. From bailout to exit in three years via a 38% increase in exports and a 13% improvement current account balance as a percentage of GDP. Yet – as is symptomatic of the region as a whole – Portugal’s debt and unemployment problems remain acute, whilst deflation is increasingly a haunting presence. The European Commission still expects Portugal’s gross public debt to be 126% of GDP in 2014, whilst unemployment is over 15% compared with 8.7% in Q3 2008.
Last week, Brussels lowered its forecast for Eurozone inflation for the second time in three months to 0.8% in 2014, from 1%. This only rises to 1.2% in 2015. The ECB still seem likely to tread their cautious monetary path for another month following positive PMI numbers. However, it’s a precarious position for a region with record debts of 96% of GDP this year, which only fall marginally to 95.4% in 2015. Tough to see how they get through 2014 without some real monetary action.
Too good? The UK’s housing recovery
The UK economy is cruising along the recovery highway. The engines of growth are firing nicely with the latest PMI figures showing contributions from manufacturing and services. Fuel is coming from improving investment and wages finally rising ahead of inflation – but with no danger of pushing the Bank of England past their CPI remit and forcing an early application of the interest rate brakes.
But, there’s a problem. The house shaped hazard light is blinking insistently on the Bank of England’s dashboard. It’s in danger of overheating! Last week the Bank gave its strongest warning yet that a housing bubble could derail the recovery. UK house prices may be below their peak, however, the disconcerting double-digit annual rate of increase in is hard to ignore. It stirs memories of the era before the financial crisis, when inflation was low and house prices boomed.
The Bank will want to toughen rules, rather than raise interest rates, which it may do at its June Financial Policy Committee meeting. However, macro prudential measures can only do so much when price expectations leap ahead. The economist consensus is for the first rate rise in Q1 2015, according to Reuters. It’s not a move that the Bank will want to make, with the UK economy’s vulnerability to higher rates belying the outward show of GDP growth.
Of course, it’s not alone in this predicament. Bank of America Merrill Lynch estimates that zero-bound rates support 56% of the global economy. It’s an exceptional time that will be very hard to leave behind.