On the increasingly meager menu of yield-generating investments, bonds sold by U.S. companies with stronger balance sheets are looking more and more like the cake that everyone wants a piece of.
Or to put it another way, as strategists at Bank of America Merrill Lynch did in a recent note, U.S. high-grade debt is "the only game in town" – featuring a heady mix of investment-grade credit ratings, yield, and size.
"For global high-grade broad market investors by now there is only one market that offers both yield and size – namely the U.S. high-grade corporate bond market," write BofAML Strategists led by Hans Mikkelsen. "In other words global high-grade investors that can buy sovereigns, supranationals, agencies, mortgages and corporate bonds are forced to flock to U.S. high-grade corporate bonds and drive credit spreads tighter."
The trend is playing out in recent data showing that yield-starved foreign investors – notably in Japan and Europe – have been snapping up U.S. assets with gusto. Analysts at Deutsche Bank AG reported "strong" demand for the nation's corporate debt in May – their last available data – with foreigners purchasing a net $12.7 billion worth of U.S. corporate bonds that month.
Companies keen to capitalize on unfettered demand for corporate debt can serve it up to hungry investors but they face a calculation in doing so, as too much issuance will weaken their respective balance sheets. Rising corporate indebtedness is fine as long as investors are willing to overlook it, but it's far from certain this dynamic can continue in the face of a slowing global economy, a U.S. earnings recession, and nervous stock market investors.
"Equity investors eventually get what they ask for, and they are asking companies to stop adding leverage," the BofAML strategists write. The trend started to play out in the first quarter, as the sum of buyback and acquisition volumes declined, and they expect it to continue.
That "eventually – as we have worked our way through the pipeline of M&A deals that have been announced but have yet to close – leads to lower leverage on high-grade corporate balance sheets," they say.
That might be good news for those worried about deteriorating fundamentals in corporate credit, but bad news for the many investors who need fresh issuance more than ever to make up for a paucity of yield. It's doubtful that companies can continue to sell new debt in the face of rising opposition to adding leverage.
After all, you can't bake a delicious yield cake without breaking a few eggs.