Even if your focus is squarely on equities, understanding what’s taking place in other markets is an important factor when it comes to managing a portfolio. It’s often said that the bond market leads stocks and the first moves to a major change in trend, whether it’s the trend in markets or economic growth often begins with fixed income. Credit markets have been garnering much more attention in the last 6-12 months. (At least judging by how much those I speak with have been talking about them.)
One such piece of evidence comes from Jeff Bahl, the former head fixed income trader at Goldman Sachs), who now manages his own fund. Bloomberg covers the story (h/t to Jesse Felder for sharing the story on Twitter). The article quotes from Bahl's most recent investor letter. I wanted to share a few points Bahl makes:
Historically, there has been a clear correlation between well-capitalized companies outperforming their weaker counterparts during periods of rising corporate leverage. However, that relationship has not held since 2011 as the market has rewarded higher leverage (indicated in the exhibit below). As a result of the positive feedback loop, debt on corporate balance sheets is now at levels not seen since the financial crisis.
Balh makes a good point that ‘high yield’ bonds should not be categorized as such based on their credit rating, since history has shown credit agencies don’t always get things right.
Rather, they should be viewed as ‘high yield…based on their actual yield' (novel idea!). He goes on to give two examples of this, using Freeport-McMoran (N:FCX) and Sprint (N:S).
He ends his letter with:
While history does not repeat, it certainly rhymes. This time it is not different. Corporations that have depended on the depth of the capital markets for their expansion are firmly in the crosshairs. As opposed to the past six years, a “V-shaped” recovery in credit spreads is not coming. Similar to the unwind of prior credit booms, this deleveraging cycle will be longer and deeper than market expectations. With a contracting credit market, further access to capital will be at progressively more punitive terms.
I’m not overly concerned about the “why” for the markets' current circumstances, there’s plenty of opinion that can point you in a million different directions, any of which will surely fit your personal bias, whether it be oil, the dollar, China, or Donald Trump. What’s important in my view is understanding that the winds are changing in the fixed income arena. There’s a hell of a lot more money at stake in credit markets, and when it moves it can have massive ripple effects.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.