David Fuller and Eoin Treacy's Comment of the Day
Category - General

    High Yield Credit Handbook

    Thanks to a subscriber for this report from Goldman Sachs which may be of interest to subscribers. Here is a section:

    HY total returns of 4.5% YTD have surpassed our YE target: In what has been a continuation of a strong 2016, total returns surpassed our Credit Strategists’ full year target of 3% by the end of the first quarter. We attribute much of the surprise to the US Treasury move lower, but also point out that current HY spreads of 390bp are ~50bp tighter YTD.

    And US Treasury rates are … lower. We entered 2017 with the expectation that three rate hikes could help drive the 10yr UST 50bp higher, to 3.00% (GS Economics view). At mid-year, UST rates have instead declined 35bp, to 2.15% (see Exhibit 1) and our Economics team recently lowered their YE2017 forecast to 2.75% (from 3.00%). To be clear, the revised target still implies a 60bp move higher which could drive a headwind of 2.85% for the HY market (based on an average market duration of 4.76 years).

    Spreads are tighter despite over $4.9bn of YTD HY outflows: With the rally in global risk assets, high yield market spreads have tightened ~50bp to 390bp, or inside the 20th percentile relative to the last 30 years. This spread move is even more surprising given it has unfolded in the face of $4.9bn of cumulative HY net outflows YTD. In fact, the HY market has experienced net cumulative outflows this late into the year only once in the last 10 years (see Exhibit 2).

    Robust primary volumes continue: HY new issue activity surpassed $300bn in each of 2012, 2013, and 2014, and breached the $250bn mark for 2015. Despite dipping in 2016 (not surprising given the weak macro backdrop in 1Q2016) to $227bn, HY issuance appears poised to make a rebound this year with volumes trending up 6% yoy.

    US policy is evolving and remains a key variable: The ramp in soft economic data (see Exhibit 3) suggests the outcome from last year’s election has positively impacted economic sentiment. However, hard economic data (like GDP), as measured by the GS Economics team has yet to inflect. For risk sentiment to remain elevated, we expect investors to be looking to the potential for the hard data to improve and growth to accelerate.

    Disruption has been dangerous… what’s the next Rental/Retail/RLEC story? As the HY market has steadily marched higher, not all credits have participated. The market has been particularly unforgiving to stories where secular disruption has emerged. The rental, retail and RLEC sectors are prime examples here (see Exhibit 4) but we also have concerns over legacy software providers, the auto sector, the hospital facilities space and certain parts of media (see p. 4).

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    Amazon Cometh to Grocery What Does it Mean?

    Thanks to a subscriber for this report from Morgan Stanley which may be of interest. Here is a section:

    2) Removing Consumers’ Online Grocery Pain Points…to Better Attack the$780bn US Grocery Market: The addition of WFM materially improves AMZN’s grocery user proposition and its ability to penetrate the ~$780bn US grocery market (See Exhibit 6). Grocery eCommerce penetration is still low (estimated 3% see Exhibit 7) in part because (per our AlphaWise survey data) consumers enjoy selecting their own food, value the in-store experience as well as the certainty that the food is correct (See Exhibit 5). The addition of WFM and its 465+ stores (across 3 countries and 42 US states) solves these points of friction. Bigger picture, this speaks to the importance of brick and mortar in certain e-commerce categories as AMZN (through WFM) and BABA (though Intime) continue to expand their attack on consumers’ wallets

    3) WFM + Prime Now = A 1-2 Hour Prime Personal Shopper: The combination of WFM’s store footprint and grocery inventory with Prime Now will enable AMZN to improve the Prime Now product…as Prime Now will be able to offer consumers grocery delivery in 1-2 hours. AMZN will also be able to leverage the store footprint to house other inventory, to expand its Prime Now selection. Prime Now just became a 1-2 hour personal shopper.

    4) Changing Consumer Behavior Again as 1-2 Hour Delivery Could Replace 2- Day Delivery Expectations: In our view, AMZN’s core business is behaviour modification, and a stronger 1-2 hour offering has the potential to further increase consumers’ expectations for e-commerce shipping times. Just as AMZN pushed expectations from a week delivery time (13 years ago) to 2 days (with Prime, introduced in 2005), a more robust Prime Now could further move the goal-posts to 2 hours. This will only further AMZN's competitive offering vs other retailers.

    5) A further driver of Prime Subscriber growth. Our Alphawise data show that ~62% of Whole Food Shoppers are Prime Members (See Exhibit 2). Amazon's ability to convert more Whole Foods shoppers into its Prime membership has the potential to lead to faster long term growth and wallet share growth. Bigger picture, 2 hour delivery could also drive faster Prime sub growth. In the words of Jeff Bezos on April 2016 "We want Prime to be such a good value, you’d be irresponsible not to be a member". 

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    China shares get MSCI nod in landmark moment for Beijing

    This article from Reuters may be of interest to subscribers. Here is a section: 

    Inclusion in the index marks a key victory for the Chinese government, which has been working steadily over the past few years to open up its capital markets, investors said.

    "Given the size and importance of China as an economic superpower, I think this is a historic moment," Kevin Anderson, senior managing director of State Street Global Advisors and head of investments in the Asia Pacific region told Reuters.

    "It's a long-awaited and much-debated decision in the past, and I think it's more than symbolic as it will create additional flow of capital and potentially a new segment of institutional investors in the China market."

    Traders said MSCI's widely expected "Yes" decision had been largely priced in, with the announcement triggering some profit-taking in blue chips, which are no longer cheap after strong rallies this year.

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    Why Britain Has to Be Really Nice to Norway and Russia

    This article by Anna Shiryaevskaya  and Kelly Gilblom for Bloomberg may be of interest to subscribers. Here is a section:

    Already buffeted by political chaos at home and abroad, the U.K. gas market must now operate without its biggest stabilizing force: the giant Rough gas storage facility under the North Sea.
    The planned permanent shutdown of the Centrica Plc site, able to meet 10 percent of peak demand in winter, means Britain is becoming even more reliant on imports of liquefied natural gas or pipeline fuel from Russia and Norway. That sets up the possibility that traders would have to outbid Japan, the world’s biggest LNG buyer, and others to keep millions of homes warm.

    Political uncertainty is making the supply game even riskier, with rules for international gas pipelines clouded in mystery as the U.K. negotiates an exit from the European Union.

    And the diplomatic crisis this month involving Qatar, the nation’s largest LNG supplier, caused gas prices in Britain to jump the most since January as two tankers were diverted.
    “It takes two weeks for a cargo of LNG to arrive from Qatar, which is not a politically stable place right now,” Graham Freedman, principal analyst for European gas and power at Wood Mackenzie Ltd. in London, said by phone.“That does raise the political implications quite a lot, along with Brexit. So it’s a perfect storm in terms of security of supply for the U.K.”
    Last winter as much as 94 percent of the country’s gas came from sources other than storage. More than half of that was imports, mainly through pipelines from Norway. Statoil ASA, Norway’s state-owned producer, has repeatedly said it doesn’t plan to significantly boost exports, but can divert more fuel to Britain if needed.

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    Aussie Banks Seen Set to Dodge Debt Cost Pain After Moody's

    This article by Ruth Liew for Bloomberg may be of interest to subscribers. Here is a section:

    Surging home prices in cities like Sydney along with rising household debt and sluggish wage growth pose a threat to lenders, according to Moody’s. But the four banks likely won’t have to pay more to issue debt for now, as they remain in the “rare company” of lenders around the world that hold AA level ratings, said Vivek Prabhu, Sydney-based head of fixed income at Perpetual Ltd.

    “Any further downgrade would take them into the A rating band and could lead to a more meaningful increase in the cost of wholesale debt funding if this were to occur,” he said.

    Australian banks are lenders to some of the most indebted people on the planet. The combination of eye-watering house prices and anemic wage growth has pushed the ratio of household debt to disposable income to 189 percent -- one of the highest levels globally. Every basis point paid to borrow counts for the lenders, who source about two-thirds of their funding from deposits and the rest from debt markets from Australia to the U.S.

    Australians piling on mortgage debt has been a key concern of Moody’s, Frank Mirenzi, a senior analyst, told Bloomberg TV Tuesday. “We just don’t know how these mortgages will perform during a real downturn,” he said.


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    Fed plan to reverse QE is fraught with danger

    This article by Ambrose Evans-Pritchard for The Telegraph must have touched a nerve among investors because I received multiple emails asking about it. Here is a section: 

    It typically takes about 500 basis points of Fed cuts to fight bad recessions. It was even worse after the Lehman crash in 2008. The Fed ran out of ammunition after 475 points and had to flood the system with liquidity through QE. The total was, in synthetic terms, 850 points of loosening.

    As matters now stand, the Fed has just 100 basis points of cuts to play with in a crisis. Prof Blanchflower said: “We should be getting as far away as possible from the zero-lower-bound [zero rates] before selling off any assets, otherwise we are going to have a disaster.”

    What makes this so sensitive is that the window for QE in the future is closing. The two new Fed members floated by the Trump administration, Randal Quarles and Marvin Goodfriend, are both staunch conservatives hostile to QE. The bar will be higher. This means the Fed may have to fight the next downturn with little in the arsenal.

    It is going to be pretty unpleasant if we hit a crisis with only four rate cuts to play with and no QE.

    One ex-Fed official said: “It is going to be pretty unpleasant if we hit a crisis with only four rate cuts to play with and no QE. The whole universe of asset prices is built on the assumption there will always be a ‘Fed put’ and bond yields will never be allowed to rise.”
    Professor Tim Congdon, founder of the Institute of International Monetary Research, said quantitative tightening would compound the monetary squeeze just as big banks were already having to boost their loss-absorbing capital to 16pc of risk-weighted assets under the Basel rules.


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