Eq: Large Cap
The US auto industry has a huge problem, and if you’ve ben paying attention, you should already be starting to become aware. Consider this: the US economy has been doing great and the employment market is tight, yet US automakers are closing factories and cutting their workforces left and right. The disconnect comes down to an important issue—US auto factories are not aligned with customer demand. Traditional sedans are rapidly losing market share, yet US auto plants are set up to produce them. SUVs are taking over American car purchases, but automakers aren’t equipped to meet demand.
FINSUM: This is an eye-opening issue, but surely the problem of shifting demand is better than demand falling in aggregate. It does seem like there are going to be some rough years as automakers play catch up.
The junk bond market is going through an eye-opening drought. Not one company under investment grade has issued a bond since November, the longest spell of this kind in more than two decades. Investors are worried over the economy and market volatility, which has basically shut down any new issuance. It has now been 41 days since a junk bond sale, the longest period since 1995. December was the first month since 2008 without a junk bond sale.
FINSUM: When credit starts to get ugly, investors would be wise to pay attention. The question is whether this is just a short-term hiatus or a sign of worse things to come.
While the stock market is getting all of the attention, the bond market is experiencing a lot of turbulence as well. The riskiest corners of the debt market, including junk bonds and loans, are on pace for their worst month since the US downgrade in August 2011. High yield’s spread to Treasuries has surged a whopping 110 basis points since the start of the month, and unlike in stocks, there aren’t signs of a rebound. The average yield on the index is 8%.
FINSUM: It is reasonable to be nervous about credit right now given the huge volume of issuance in recent years and the pending threat of a recession and accompanying earnings slowdown.
2018 was a tough year for most income investors. Rates rose considerably, making the dividend yield of the market look rather poor compared to many other short-term assets. Strong corporate dividend hikes helped, but the big question is what will happen in 2019. Most analysts think the pace of dividend hikes will slow, but so will the pace of rate hikes, meaning that income stocks seem likely to do well. Dividends rose 9% this year and are expected to rise 6% in 2019.
FINSUM: Goldman says that financial firms will raise their dividends by 16% in 2019, more than any other sector. Perhaps that is a good place to look.
In many ways credit markets are a major bellwether for both the economy and the stock market. And right now, they are sending some poor signals. Investors are afraid of rate hikes and money managers are refusing to bankroll buyouts. As a gauge to how brutal the environment is, consider this: not one company has borrowed in the US high yield market this month! A strategist from Janney Montgomery Scott put the current market environment in perspective: “This is clearly more than year-end jitters … What we’re seeing now is pretty typical for end-of-credit-cycle behaviour”. Yields on junk bonds have climbed over 100 basis points since mid-September.
FINSUM: Junk bonds are likely feeling more heat from the worries about a recession and weakening of earnings (in light of high indebtedness) than they are interest rates.
How to protect against the next recession? This is a difficult question. Since it may be rate induced, it will be hard to hide out in Treasuries, and gold has not inspired much confidence. Well, SkyBridge Capital thinks the big money maker is to short high yields. “Our largest short position right now is in high yield, and it’s not because we think we’re going to make money this year or next year … It’s to protect against the eventual recession or [a] surprise recession”, says a portfolio manager there. “If you’re looking to put on [a] relative cheap short position, it’s hard to figure out how you lose money given how tight spreads are”.
FINSUM: High yield has seen a big expansion of credit and a decline in quality, and when the next recession rolls around there are going to be some big losses.