Pimco Sours on Financial Bonds in Record Rally: Credit Markets
Financial bonds worldwide are on pace for their best annual returns on record, leading investors from Pacific Investment Management Co. to DoubleLine Capital LP to see an end to the four-year-old rally.
Debt of lenders from JPMorgan Chase & Co. (JPM) to HSBC Holdings Plc (HSBA) is headed for a 15.4 percent gain this year, poised to exceed the unprecedented 15.2 percent in 2009, according to Bank of America Merrill Lynch index data. The bonds are beating industrial notes by 4.3 percentage points in 2012, the biggest outperformance ever.
Speculation is growing that the rally has pushed yields down to levels that fail to compensate for the risk that the global economy slows further and Europe’s debt crisis worsens, hurting a global banking system that’s increasingly interconnected. Pimco (PTTRX), which 15 months ago said the bonds had room to rise, now is selling the debt, favoring energy and building materials instead.
“The rally in financial debt is mostly over,” Mark Kiesel, global head of corporate bond portfolios at Pimco, said yesterday in a Bloomberg Television interview. “We’re taking profits; we’re reducing our exposure overall.”
The gap in relative yields between dollar-denominated financial and non-financial bonds is at about the tightest level since February 2008, Bank of America Merrill Lynch index data show. The difference reached 34 basis points on Oct. 17, before widening to 39 basis points as of Oct. 22.
The International Monetary Fund has lowered its global growth forecast to the slowest pace since the 2009 recession. Concern that Europe may cause an international financial contagion is mounting as Spain’s economy contracts for a fifth quarter and Greece struggles to obtain international aid.
“It’s difficult to see the catalyst for further tightening in bank spreads,” said Bonnie Baha, head of global developed credit at Los Angeles-based DoubleLine, which oversees more than $45 billion. “They’ve had a terrific run this year.”
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. increased, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, climbing 0.3 basis point to a mid-price of 97.2 basis points as of 11:10 a.m. in New York, according to prices compiled by Bloomberg.
The measure typically rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point, or 0.01 percentage point, equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell 0.75 basis point to 10 basis points as of 11:11 a.m. in New York. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
Bonds of Plains Exploration & Production Co. are the most actively traded dollar-denominated corporate securities by dealers following yesterday’s $3 billion offering, with 260 trades of $1 million or more as of 11:14 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The company’s $1.5 billion of 6.875 percent securities due February 2023 sold at par increased to 100.8 cents on the dollar to yield 6.77 percent, Trace data show.
Financial obligations are on pace for a fourth year of gains after tumbling 7.4 percent in 2008 as the failure of Lehman Brothers Holdings Inc. ignited the worst financial crisis since the Great Depression, Bank of America Merrill Lynch index data show. The notes have returned 12.3 percent this year compared with an 8 percent increase for non-financial borrowers.
Yields on JPMorgan’s corporate bonds have declined by 1.69 percentage points this year to an average of 2.27 percent, Bank of America Merrill Lynch index data show. Yields on HSBC have dropped by 1.92 percentage points to 3.12 percent.
The extra yield investors demand to own financial bonds globally rather than government debt has dropped 185 basis points since year-end to 183 basis points, according to Bank of America Merrill Lynch index data. That’s almost three times the 66 basis-point drop to 131 basis points for industrial firms from AT&T Inc. to Toyota Motor Corp.
Relative yields for financial firms have plunged from as high as 686 basis points in March 2009, index data show. Industrial spreads peaked at 494 basis points in December 2008.
“Because the valuations have changed, we’re no longer as excited about the return prospect,” Pimco’s Kiesel said in an interview at Bloomberg headquarters in New York.
Investors have been buying riskier debt with the Federal Reserve holdings its benchmark interest rate in range of zero to 0.25 percent since December 2008.
Fed Chairman Ben S. Bernanke said Sept. 13 that policymakers expected to hold down the target through mid-2015 and committed to buying $40 billion of mortgage bonds a month. European Central Bank President Mario Draghi announced an agreement on Sept. 6 for an unlimited bond-buying program to tamp down interest rates and fight speculation of a currency breakup.
Investment-grade bond fund inflows this year of $105 billion compare with $74 billion in all of 2011, according to JPMorgan research.
Banks are reducing debt as the Dodd-Frank Act’s Volcker Rule in the U.S. seeks to limit risk-taking at the biggest financial institutions and after the 27-country Basel Committee on Banking Supervision raised minimum capital requirements in 2010.
AllianceBernstein LP’s Ashish Shah sees potential for further gains as banks cut their debt levels, leading to a shrinking supply of the notes. Relative yields on financial notes that are wide compared with historical averages also make the notes attractive, he said.
“There’s still a healthy spread premium versus any history,” said Shah, head of global credit investments at the New York-based firm, which oversees about $245 billion in fixed- income assets.
Bank bonds yielded an average of 33 basis points less than industrials in the five years before Lehman’s failure on Sept. 15, 2008. Since then, yields on financial notes have been an average 77 basis points higher than industrial debt.
“There are scenarios where you could see that happen again,” he said. “I don’t think at this point though. You still have Europe as a big concern.”
The IMF is predicting the world economy will grow 3.3 percent this year and 3.6 percent next year, it said on Oct. 9. That compares with July predictions of 3.5 percent in 2012 and 3.9 percent in 2013. The Washington-based lender now sees “alarmingly high” risks of a steeper slowdown, with a one-in- six chance of growth slipping below 2 percent.
Spain’s gross domestic product fell 0.4 percent in the third quarter, the Bank of Spain said yesterday. Spain’s bonds have declined since European Union leaders last week failed to discuss further aid for the nation at a Brussels summit.
Greek Prime Minister Antonis’s race to obtain 31 billion euros ($40.3 billion) of aid is running into renewed opposition from his coalition partners who balked over demands from the country’s lenders for labor law changes.
Bank notes “still offer value, but not as great a relative value as they did earlier in the year,” said Chris Harms, a fixed-income money manager at Loomis Sayles & Co., which oversees $181.5 billion. “We could trade sideways for many years to come.”
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