Buybacks to Dividends at Risk With Record-Low U.S. Yields Ending
Comment of the Day

September 03 2013

Commentary by Eoin Treacy

Buybacks to Dividends at Risk With Record-Low U.S. Yields Ending

This article by Whitney Kisling and Nick Taborek for Bloomberg may be of interest to subscribers. Here is a section
Buyback plans have slowed as the Fed prepares to curtail the bond-buying program. Less than $50 billion was announced in each of the past two months, compared to more than the $68 billion average of January through June, according to Birinyi data. Repurchases dropped 3.2 percent to $118.5 billion in 2003, the last year before the Fed started raising rates.

Corporate bond sales also have started to slow, after reaching a global record of $3.99 trillion in 2012. After $1.1 trillion was issued in the first quarter this year, sales slipped to $925.8 billion in the second, data compiled by Bloomberg show. June's $196.8 billion was the slowest month since December 2011

Eoin Treacy's view Many retail investors focused their attention on the bond markets, having had their confidence rattled during the credit crisis. Meanwhile corporations took advantage of the lowest cost of capital in a generation to refinance higher cost bonds and loans and to increase their overall debt burden. They then used some of the additional cash to buy back prodigious quantities of their own stock and/or to increase dividends. This corporate demand constitutes an important source of fuel for the rally from the 2009 lows.

While BBB corporate bond spreads have been relatively stable, the chart of yields in absolute terms is more instructive of what is really going on. 9% has been an area of resistance for BBB yields on at least three occasions since 1992 and yields most recently tested that level in early 2009. Since then, ultralow interest rates and a desire to capture yield contributed to yields falling to an historic low near 3.3% by May. Over the last few months yields have rallied to break the medium-term progression of lower rally highs and the 200-day MA has turned upwards for the first time in four years. At this stage, it is reasonable to conclude that the low near 3.3% is unlikely to be retested and a sustained move below 4% would be required to begin to question medium-term supply dominance.

So far the rise in corporate bond yields has mirrored that of Treasuries but there is no guarantee that the 170 basis points spread on BBB can be sustained indefinitely. In fact the higher absolute yields move, the greater pressure less well capitalised firms will come under and therefore spreads can be expected to rise as the new credit cycle progresses.

In terms of the equity markets, the remarkable outperformance of the Buyback Achievers (Also see comment of the Day on August 22nd .) is likely to be a bellwether for the wider market since these companies have been among the most active participants in the bull market to date. The Powershares ETF is currently in a process of mean reversion following an impressive rally from the June lows. However, a sustained move below the 200-day MA will be required to question the broad consistency of the overall uptrend

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