“The Smart Money is Selling Debt”
If you are a corporate CFO, now is the time to issue bonds because interest rates are very low, courtesy of the Federal Reserve. And companies are doing that from IBM, to J&J and Microsoft. These companies don’t need the money; they see ‘free money’ in the form of abnormally low rates and decide to issue now while the getting is good. In fact, as I alluded to in the Grantham post, it is the riskiest enterprises which should benefit the most from low rates and that is certainly the case today. Bloomberg reports:
The lowest-rated junk bonds are the most expensive corporate debt following a Federal Reserve- induced rally in high-risk assets, adding to concern fixed- income securities are overvalued.
The extra yield investors demand to hold global bonds rated CCC or lower instead of government debt is about 10.1 percentage points, or 3.4 percentage points narrower than the average over the past 12 years, according to Bank of America Merrill Lynch index data. Debt with B ratings is the only other part of the market trading tighter than its historical average.
Record-low interest rates in the U.S. and Europe, and speculation the Fed will purchase more bonds to keep the economy from faltering, are encouraging debt investors to take on riskier securities and stoking concern prices are rising to unsustainable levels. Goldman Sachs Group Inc. advised its clients to avoid adding CCC rated debt in a report published Oct. 22 because of slower economic growth.
“With CCCs even more richly valued than historically, the risk of poor relative returns in the future would appear to be high,” said Martin Fridson, a global credit strategist in New York at BNP Paribas Asset Management, who began his career as a corporate debt trader in 1976. “You have to be conscious of that risk of underperformance. Having relatively rich valuations puts investors at a handicap.”
There has been record issuance in the high yield market as a result. Now, there seems to be a trend toward longer-duration paper. The thinking goes, "why not lock in these rates for 50 or 100 years instead of 10 years?" And that is what we saw with Mexico issuing a 100-year bond with a 6-handle. In the corporate sector, Goldman Sachs has followed with a 50-year $1.3 billion deal, with retail investors accounting for 80 per cent of the demand.
In the five-minute video clip below analyst Bill Smead, CEO and CIO of Smead Capital Management, says "the smart money is selling debt." You don’t get these kind of opportunities that often. Smead says this is a symptom of a misallocation of capital. Will these low rates lead to capital investment and economic growth, though?