Nowhere to Hide in Worst Bond Losses Since 2008: Credit MarketsVictoria Stilwell
Investors are finding no shelter from the worst corporate-bond losses in almost five years as debt plunges for the most creditworthy to the riskiest borrowers in every industry worldwide.
Company debentures erased 2.2 percent the last three months, the worst quarterly decline since a 5.2 percent plunge in the period ended September 2008, when the collapse of Lehman Brothers Holdings Inc. ignited the worst credit crisis since the Great Depression, Bank of America Merrill Lynch index data show. All 16 industries in the index lost during the period, from a 0.7 percent decline for the debt of automakers to a 3.5 percent drop in energy-company bonds.
Speculation that Federal Reserve Chairman Ben S. Bernanke may soon lead a pullback from unprecedented stimulus efforts fueled a 1 percentage point jump in 10-year Treasury yields the past two months. That sparked withdrawals from bond funds and a slowdown in corporate debt issuance from a record pace. Royal Bank of Scotland Group Plc strategists in the U.S. lowered their predictions for 2013 gains last week.
“There has been no safe haven,” said Jeroen van den Broek, head of credit strategy for ING Bank NV in Amsterdam, who recommends investors buy credit, with a preference for investment-grade debt. “We’re seeing a complete focus on rates and everything surrounding Bernanke.”
Even junk-rated bonds, typically considered a buffer against rising interest rates because they offer larger relative yields over Treasuries, lost 1.5 percent in the second quarter, compared with a 2.4 percent decline for investment-grade notes.
By comparison, when 10-year Treasury yields surged 1.45 percentage points during two months in 2003, speculative-grade debt fell 2 percent, less than half the 4.3 percent drop in their higher-graded, lower-yielding counterparts.
“High yield has been hit more than we would have expected, especially considering the losses we see in investment grade,” said Putri Pascualy, the senior credit strategist at Pacific Alternative Asset Management Co. in Irvine, California, which oversees $4 billion in fixed-income investments. “It’s not cheap, but it’s approaching fair value.”
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. and Europe fell to the lowest in almost two weeks. Egypt’s borrowing costs and credit risk climbed to records as masses poured into the nation’s streets demanding President Mohamed Mursi step down, prompting the military to threaten intervention. Alstom SA, the world’s third-largest power-equipment maker, sold bonds for the first time since October.
The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, dropped 2.6 basis points to a mid-price of 84.5 basis points as of 12:09 p.m. in New York, poised for the lowest closing level since June 18, according to prices compiled by Bloomberg.
In London, the Markit iTraxx Europe Index fell 4.5 to 114.7, the lowest since June 19.
Both indexes typically decline as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt.
Credit swaps protecting Egyptian debt against default for five years climbed 18 basis points to 900, heading for the highest closing level on record after surging 261 basis points in June, according to data provider CMA, which is owned by McGraw Hill Financial Inc. and compiles prices quoted by dealers in the privately negotiated market.
The yield on the government’s benchmark $1 billion of 5.75 percent Eurobonds due in April 2020 rose 18 basis points to 10.33 percent at 4:57 p.m. in Cairo. The yield jumped 211 basis points, or 2.11 percentage points, in June.
The military said it will intervene if the government doesn’t find a solution to the crisis in the next 48 hours. Anti-government demonstrations intensified today, with protesters storming the headquarters of the Muslim Brotherhood and setting it ablaze. The violence reflected the magnitude of the rift dividing the nation as Mursi’s supporters vowed to protect him on grounds he was democratically elected a year ago.
Bonds of Fairfield, Connecticut-based General Electric Co. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 3.7 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Alstom sold 500 million euros ($653 million) of six-year, 3 percent securities to yield 165 basis points more than the mid-swap rate, according to data compiled by Bloomberg. That compares with an average 140 basis-point spread for similarly-rated BBB securities, Bank of America Merrill Lynch index data show.
Corporate-bond sales of $196.8 billion worldwide in June were the least since December 2011, bringing this year’s total to $2 trillion, Bloomberg data show. That’s more than the $1.96 trillion sold in the first six months of 2012, a year in which offerings reached a record $3.98 trillion worldwide.
U.S.-listed bond mutual funds and exchange-traded funds posted record monthly redemptions of $61.7 billion through June 24, surpassing the previous record of $41.8 billion in October 2008, according to an e-mailed statement last week by TrimTabs Investment Research in Sausalito, California.
The bond-market selloff accelerated after Bernanke said June 19 the Fed may start dialing down its $85 billion monthly bond purchasing program this year and end it entirely in mid-2014 if growth is in line with the central bank’s estimates.
The comments sparked declines from bonds to stocks as investors weighed the possibility of an end to easing that has suppressed interest rates, pushing investors into riskier assets and helping to keep the U.S. growing in the face of federal budget cuts, a slowdown in China and a recession in the euro area. Less than two months before Bernanke’s comments, global corporate-bond yields touched a record-low 3.09 percent.
“The initial reaction was just to sell everything,” Regina Borromeo, a money manager at Brandywine Global Investment Management LLC, which oversees $36 billion in fixed-income assets, said in a telephone interview from London. Rising rates are logical in light of a gradually recovering U.S. economy, “but the magnitude of the move and the indiscriminate selling was a surprise to us,” she said.
The second-quarter decline more than erased a 0.8 percent gain in the three months ended in March, leaving investors with a 1.4 percent loss since year-end on the Bank of America Merrill Lynch Global Corporate & High Yield index, the worst first-half performance in records dating back to 1997.
Investment-grade securities, which posted their worst June on record with a 2.4 percent decline, have lost 1.96 percent this year. Junk bonds declined 2.8 percent last month, paring the year’s gain to 1 percent, the smallest first-half returns since 2008. Speculative-grade debt yields fell to a record 5.94 percent on May 9, a week after its duration, a gauge of the securities’ price sensitivity to rate moves, touched a two-year high of 4.71.
Emerging-market securities are leading the declines as rising interest rates discourage investors from lending to companies in developing nations.
Bonds of state-owned oil company Petroleos Mexicanos have dropped the most among the top 50 issuers this year, with an average 7.1 percent loss. Debentures of Petroleo Brasileiro SA, the most indebted publicly traded oil company, posted a 6.3 percent decline.
European bank bonds have performed the best this year, with French bank Credit Agricole SA debt gaining an average 2 percent to lead the biggest issuers as the lender completed the sale of its Greek consumer-bank unit in February and shut its riskiest investment-banking businesses.
Lloyds Banking Group Plc, which is 39 percent-owned by the U.K. government, has returned 1.6 percent, while Intesa Sanpaolo SpA, Italy’s second-biggest bank, has advanced 1.4 percent.
Corporate debt pared losses last week as Fed officials stepped up a campaign to damp expectations that an increase in the benchmark interest rate will come sooner than previously forecast. In Europe, European Central Bank President Mario Draghi said June 26 that policy makers will maintain a loose monetary stance for as long as needed.
Bond yields and risk spreads were too low two months ago and “the Fed tilted over-risked investors to one side of an overloaded and over-levered boat,” Bill Gross, manager of the world’s largest mutual fund at Pacific Investment Management Co., said in a July investment outlook note posted on Pimco’s website on June 26. “We like bonds here. They won’t make you rich, but the May/June experience is unlikely to be replicated in 2013,” Gross wrote on Twitter two days later.
As rates begin to stabilize, investors will return to the corporate-debt market, according to Ashish Shah, head of global credit investment at New York-based AllianceBernstein Holding LP, which oversees about $250 billion in fixed-income assets. Ten-year Treasuries have eased 18 basis points from a near two-year high of 2.66 percent reached June 24.
“These types of moves burn themselves out,” Shah said. “We’re in the tail end of this thing, and I do think we’re at a stage where now is a good time to buy.”
U.S. issuance this year will decrease “modestly” from last year’s record pace as many issuers have already completed their long-term refinancing plans and with Treasury yields elevated above historical lows, RBS strategists led by Edward Marrinan wrote in a June 28 report. Investment-grade credit will return 0.6 percent this year, down from the 3.5 percent projected in December, they said. Junk-rated debt will return 8.3 percent, compared with the 8.9 percent seen earlier.
JPMorgan Chase & Co. expanded its recommendation for investors to favor equities over fixed-income investments, saying they should be underweight both government debt and corporate credit “given now more clearly negative price momentum,” Jan Loeys, the bank’s chief market strategist, wrote in a June 26 note.
“In an environment like this, it’s going to be an awkward dance,” Pacific Alternative Asset’s Pascualy said in a telephone interview. “The Fed takes one step forward, and the market takes two back. As hard as it is, you just have to look at the long-term expectations.”