Rollover risks rising on high-yield bonds
Emerging market corporate debt is in high demand, as we pointed out in this article yesterday. But we noted headwinds too, not least the amount of debt that will fall due in coming years as a result of the current bond issuance bonanza.
David Spegel, head of emerging debt research at ING in New York is highlighting a new danger — that of the exponential increase in speculative grade debt, especially from developed markets, that is up for rollover in coming years. A swathe of credit rating downgrades for European companies this year mean that many fund managers who bought high-grade assets, have now found themselves holding sub-investment grade paper. He calculates in a note this week that $47 billion of “junk” rated European paper will find itself up for refinancing in the first half of next year, more than double the levels that were rolled over in the first half of 2012.
It gets worse. The big danger now is that as Spain and Italy tumble into the junk-rated category (Ratings agency S&P on Wednesday cut Spain to BBB-, just one notch above junk) their blue-chip companies may well have to follow suit. Spegel estimates over $100 billion in Spanish and Italian BBB rated corporate bonds are due next year. If these slip into speculative grade, it would triple the amount of high-yield paper that needs refinancing in the first six months of 2013.
The picture is slightly less dire in the United States next year but it worsens in 2014 when high-yield debt redemptions total $121 billion, or a 60 percent jump from 2012 levels, Spegel says, adding:
Should risk-appetite sour…refunding may prove problematic for many global speculative grade corporates, in which case we could look forward to significantly higher global default rates as soon as 2014.
See the graphic below for the high-yield debt rollover picture in coming years:
Bond markets face higher risks in the high-yield market as more and more paper is tagged junk. Spain and Italy will be the big dangers for emerging corporate debt. Join Discussion
Iran currency plunge an omen for change?
In recent days Iranians all over the country have been rushing to dealers to change their rials into hard currency. The result has been a spectacular plunge in the rial which has lost a third of its value against the dollar in the past week. Traders in Teheran estimate in fact that it has lost two-thirds of its value since June 2011 as U.S and European economic sanctions bite hard into the country’s oil exports. The government blames the rout on speculators.
According to Charles Robertson at Renaissance Capital, the rial’s tumble to record lows and inflation running around 25 percent may be an indicator that Iran is moving towards regime change. Robertson reminds us of his report from back in March where he pointed out that autocratic countries with a falling per capita income are more likely to move towards democracy. (Click here for what we wrote on this topic at the time)
He says today:
The renewed collapse of the currency recently suggests sanctions are working towards that end.
Iran’s 2009 per capita income of over $10,000 would put it among the countries that have a 5.1 to 15.5 percent chance of democratisation if incomes shrink, according to Robertson’s calculations in March, based on past regime changes in other countries. (Iran itself could argue, reasonably enough, that it is the most democratic country in the region — everyone over the age of 18, including women, are allowed to vote, though the choice of candidates is restricted)
Furthermore, 17% of the population is comprised of young men aged 15-29 (more than in the Arab Spring countries of Tunisia, Egypt, Syria or Libya) — another underlying factor that could trigger unrest, according to his research.
Now that Iran is feeling the sting of the sanctions, it remains to be seen whether income levels will reach levels low enough to trigger the regime change anticipated by the report.
Iran's rial has plunged in value as economic sanctions bite. According to one report, this could be a sign the country is moving towards regime change. Join DiscussionThis is the biggest load of crap I have heard yet. You think the government of Iran will change??? Hahahahaha
The government of the US will fall before Iran’s. So keep waiting….
Obama better bet for US stocks?
The wealthy in the United States have a reputation for being firmly on the side of the Republican Party, but maybe they shouldn’t be for the November presidential election.
According to Tom Stevenson, investment director at asset manager Fidelity Worldwide Investments, past evidence points to Democrat Barack Obama as possibly the more lucrative bet for equity investors. He says:
Looking at stock market performance following the last 12 elections suggests that investors should, in the short term at least, be rooting for an Obama victory. History shows that markets tend to rally after a win for the incumbent party by more than 10% on average, but fall modestly if the challenger is successful.
The graphic below provides the comparitive returns after Democrat and Republican presidential election victories.
But there’s more. U.S. Big Business tends to support the Republican Party which supports lower taxes and less government involvement in the economy. But Fidelity says this stance has not delivered stock market returns; in fact the S&P 500 has delivered an average annual return of over more than 10% under the Democrats in the past half century, compared with around 5% under the Republicans, Fidelity says.
Should equity investors be rooting for Obama? Fidelity's analysis of 50 years of U.S. stock market performance shows a victory for the incumbent has delivered better returns while stocks have also performed better during Democratic presidential terms. Join DiscussionShadow over Shekel
Israel’s financial markets had a torrid time on Monday as swirling rumours of an imminent air strike on Iran caused investors to flee. The shekel lost 1.4 percent, the Tel Aviv stock exchange fell 1.5 percent and credit default swaps, reflecting the cost of insuring exposure to a credit, surged almost 10 percent.
There has been a modest recovery today as the rumour mills wind down. But analysts reckon more weakness lies ahead for the shekel which is not far off three-year lows. Political risks aside, the central bank has been cutting interest rates and is widely expected to take interest rates, currently at 2.25 percent, down to 1.75 percent by year-end. Societe Generale analysts are among the many recommending short shekel positions against the dollar. They say:
Expect the dovish stance of the Bank of Israel to remain well entrenched for now.
That’s not all. Investors have been pulling cash out of Israel’s financial markets for some time (Citi analysts estimate $1.6 billion fled in the first quarter of the year). After running current account surpluses for more than 8 years, Israel now has a deficit (the gap was $1.7 billion in the first three months of this year, double the previous quarter) .
Looking behind the scenes, a key factor behind shekel performance is the relative performance of Tel Aviv stocks versus the U.S. market, says Citi analyst Neil Corney. Last year, Tel Aviv fell more than 20 percent and it hasnt recovered this year. New York’s S&P500 on the other hand has rallied 12 percent so far in 2012 and outperformed last year as well. Corney tells clients:
Local investors in Israel always have a massive home bias but have been investing abroad for a number of years now. However, whilst the local market was outperforming the U.S. markets, they generally would hedge their exposure back to shekels. The inflows into the local real money accounts are strong and growing and the recent underperformance of the local market has led us to a ….phenomena of investing abroad but without the currency hedge. The general rule of thumb that I followed was at least one quarter of underperformance would cause local real money to increase their offshore investments and increase their short shekel position.
Quite simply, these outbound investors are betting the shekel will at best not strengthen much in the short-term, so it makes sense for them to stay unhedged.
After running current account surpluses for more than 8 years, Israel now has a deficit Join DiscussionOlympic medal winners — and economies — dissected
The Olympic medals have all been handed out and the athletes are on their way home. Which countries surpassed expectations and which ones did worse than expected? And did this have anything to do with the state of their economies?
An extensive Goldman Sachs report entitled Olympics and Economics (a regular feature before each Olympic Games) predicted before the Games kicked off that the United States would top the tally with 36 gold medals. It also said the top 10 would include five G7 countries (the United States, Great Britain, France, Germany and Italy), two BRICs (China and Russia), one of the developing countries it dubs Next-11 (South Korea), and one additional developed and emerging market. These would be Australia and Ukraine, it said.
Close enough, except that Hungary took the place of Ukraine as the emerging economy in the Top 10 and the United States actually took 46 gold medals — more than Goldman had predicted.
Goldman Sachs quite rightly pointed out in its report that progress and improvement in economic growth have historically equaled progress in sport –check out South Korea’s 13 golds in London compared with none in Munich 40 years ago; its per capita income is now $23,000 compared with $2,300 back then. Clearly wealth is key: hence 9 of the top 20 medal winning nations also have among the highest per capita incomes.
Second, countries with a socialist past (or present) also usually put up a strong showing even if the people are poorer — 8 of the top 20 from London are either communist (China, Cuba and North Korea) or ex-Soviet bloc (Russia, Hungary, Kazakhstan, Ukraine and the Czech Republic).
Now for the euro zone. There has been some hand-wringing in Germany, France and Austria about their relative performances. The first two received 11 golds each (compared to the 14-plus that were targeted) while Austria go home with no medals at all, gold or otherwise, for the first time in 50 years. (Lets wait until 2014 to see how the Austrians do at the Winter Olympics).
In the euro zone periphery, Italy fared best, landing 8 gold medals for 8th place, though less than the 10 that Goldman had predicted. Spain failed to break the top 20, with just 3 golds (it took 5 in Beijing and Goldman had forecast it would get 6 this time).
Higher per capita incomes, higher economic growth, host nation advantage, all these are key for Olympic medals. But as always, there are exceptions. Join DiscussionEmerging debt default rates on the rise
Times are tough and unsurprisingly, default rates among emerging market companies are rising.
David Spegel, ING Bank’s head of emerging debt, has a note out, calculating that there have been $8.271 billion worth of defaults by 19 emerging market issuers so far this year — nearly double the total $4.28 billion witnessed during the whole of 2011.
And there is more to come — 208 bonds worth $75.7 billion are currently trading at yield levels classed as distressed (above 1000 basis points), Spegel says, while another 120 bonds worth $45 billion are at “stressed” levels (yields between 700 and 999 bps). Over half of the “distressed” bonds are in Latin America (see graphic below). His list suggests there could be $2.4 billion worth of additional defaults in 2012 which would bring the 2012 total to $10.7 billion. Spegel adds however that defaults would drop next year to $6.8 billion.
Now for the good news. These default rates, seen peaking in November at 3.6 percent, are actually pretty low (Emerging market defaults rose to 13.75 percent in December 2009 and were at a record high 30 percent during the 2001-2002 crisis) and Spegel estimates that the worst is now past. Second, default rates in EM are neck and neck with U.S. speculative grade corporates and should have the edge by year-end, according to ING. The note says:
Debt default rates in emerging markets are running at twice last year's levels, data from ING Bank shows. There will be more before year-end but the worst may be over, ING analyst David Spegel says. Join DiscussionEmerging markets’ higher yields, despite comparable default rates, should help entice further flows from developed markets….Emerging corporate spreads remain significantly more alluring than those in the United States even in the high-grade arena.
America Inc. share of GDP – 12 or 3 pct?
Wall Street has been doing pretty well in recent years. Just how well is illustrated by the steady rise in corporate profits as a share of the national economy. Look at the following graphic:
The profits share of GDP in the United States must rank as one of the most chilling charts in finance.
What this means is that around 12 percent of American gross domestic product is going to companies in the form of after-tax profits. A year ago that figure was just over 10 percent and in 2005 it was just 6 percent. In contrast, the share of wages and salaries in the U.S. GDP fell under 50 percent i n 2010 and continues to decline. Comparable figures for the UK or Europe are harder to come by but analysts reckon the profits’ share is within historical ranges.
Yet HSBC does not feel U.S. profit-GDP ratio levels are unsustainable. Analysts there argue that comparing profits to U.S. GDP alone gives an inaccurate reading because U.S. companies operate all all over the world and increasingly, their profits come from fast-growing emerging markets. There is truth in that. Just check out Coca-Cola’s results today showing Latin America sales volumes rising 3 times faster than in the home markets of North America. HSBC analysts write:
There is a widely held perception that profit levels are unsustainable. The argument goes that the profits share of GDP is high and ultimately it will mean revert. However, the profits share is not high when compared to World GDP, which we argue is the appropriate yardstick.
So compare U.S. profits with world GDP and the figure suddenly looks quite reasonable — under 3 percent. This points to a radically different picture and profits’ share here is not out of line with the historical range, HSBC adds.
Company profits' share of GDP has risen to an 85-year high of around 12 percent in the United States. But HSBC analysts argue that a more appropriate yardstick, given companies' multinational operations, should be world GDP. Join DiscussionFood prices may feed monetary angst
Be it too much sun in the American Midwest, or too much water in the Russian Caucasus, food supply lines are being threatened, and food prices are surging again just as the world economy slips into the doldrums.
This week, Chicago corn prices rose for a second straight day, bringing its rise over the month to 45%, and floods on Russia’s Black Sea coast disrupted their grain exports. Having trended lower for about nine-months to June, the surge in July means corn prices are now up about 14% year-on-year. And all of this after too little rain over the spring and winterkill meant Russia, Ukraine and Kazakhstan’s combined wheat crop would fall 22 percent to 78.9 million tonnes this year from 2011.
But as damaging as these disasters have been for local populations, their effects could be much more widely felt.
The problem is that not only do rising food prices raise the cost of living, squeezing incomes further during a downturn, but by raising inflation they severely restrict the government’s flexibility in setting monetary policy. Just as Mike argued previously on this blog that the falling oil price amounted to a green light for the cutting of interest rates, rising food prices will force many central banks to think again about the pace of monetary easing. And the problem is most acute in developing countries where the proportion of food in consumer price baskets is far higher than in the richer western economies. For example, according to the US Department of Agriculture, an additional $1 added to income sees 56 cents more spent on food, beverages and tobacco in Burundi, compared to 5 cents more in the United States.
The Russian central bank is a timely case in point when it comes to restrictions on monetary policy. On Friday they announced that they were keeping interest rates the same; as much as growth is struggling and could do with some monetary stimulus, high inflation, fuelled by food prices, is tying the bank’s hands.
Threats to the food supply are raising prices, with potentially dire consequences for emerging markets. Join DiscussionEuropean equities finding some takers
European equities are getting some investor interest again.
As the ongoing debt crisis erodes consumer spending and corporate profits, the euro zone’s share in investors’ equity portfolios has fallen in the past year –Reuters polls show holdings of euro zone stocks at 25 percent versus over 36 percent a year back. Cash has fled instead to U.S. stocks, opening up a record valuation gap between the European and U.S. shares. (see graphics below from my colleague Scott Barber). In fact no other region has ever been considered as cheap as the euro zone is now, a monthly survey by Bank of America/Merrill Lynch found in June.
That could offer investors a powerful incentive to return, especially as there are signs of serious efforts to tackle the crisis by deploying the euro zone’s rescue fund.
Pioneer Investments has moved to an overweight position on European stocks. While Pioneer’s head of global asset allocation research Monica Defend stresses the overweight is a small one compared to, say, its position in emerging markets, she says:
Cheap valuations, positioning and signs of serious efforts to tackle the euro zone problems are raising investors' interest in beaten-down European equities. Join DiscussionWe are now more positive on Europe than we have been for a long time before. From mid-June after the election in Greece and the EU summit we have become more constructive on European equities and now favour European equities to the U.S market…
The (CDS) cost of being in the euro
What’s the damage from being a member of the euro? German credit default swaps, used to insure risk, have spiralled to record highs over 130 basis points, three times the level of a year ago amid the escalating brouhaha over Spain’s banks and Greek elections. U.S. CDS meanwhile remain around 45 bps. That means it costs 45,000 to insure $10 million worth of U.S. investments for five years, compared to $135,000 for Germany. (click the graphics to enlarge)
A smaller but similarly interesting anomaly can be found in central Europe. Take close neighbours, the Czech and Slovak Republics who are so similar they were once the same country. Both have small open economies, reliant on producing goods for export to Germany.
The difference is that Slovakia joined the euro in 2009.
Back then, with the world grappling with the fallout from the Lehman crisis, Slovakia appeared at a distinct advantage versus the Czech Republic. At the height of the crisis in February 2009, Czech 5-year CDS exploded to 300 bps, well above Slovakia’s levels. But slowly that premium has eroded. A year ago CDS for both countries were quoted at similar levels of around 70 bps. Now the Czech CDS are quoted at 125 bps, having risen along with everything else, but Slovak CDS have jumped to 250 bps, data from Markit shows. (bonds have not reacted in the same manner — Slovak 1-year debt still yields around 0.8 percent versus 1.4 percent for the Czech Republic; similarly German yields have fallen to zero; for an explanation see here).
According to Benoit Anne, head of emerging markets research at Societe Generale:
Being in the euro can be costly. That's illustrated not just by the divergence between German and U.S. CDS but close neighbours, Slovakia and the Czech Republic Join Discussion