The Corporate Bond Market: Binge-Borrowing

The funny thing is California governor Jerry Brown just announced he anticipates the state will run a $1.6 billion deficit by next summer as the tax base continues to atrophy driven by – wait for it – rising taxes. And where are a lot of those tax dollars going? You guessed right again – backfilling that yawning pension gap. Will the exodus out of the Golden State continue, leaving only the uber-wealthy and economically immobile behind? You tell me.

Promise there’s a point here. Calpers will lead the way to other pensions also lowering their rate of return targets, which will in short order trigger more in the way of rising taxes and, it follows, more actual monies pensions allocate to fresh investments to thereby generate those fairy tale returns. To stay deeply deluded and convince oneself (still) high returns are achievable, the de rigueur investment is private equity credit funds in their many high voltage varieties. At Reynolds’ last count, pensions have voted a record dollar amount into credit every single month since the stock market panic of 2015.

And the momentum just keeps building. December 2015’s record pension credit fund inflows of $7.3 billion were blown to bits by this past December’s $10.6 billion – and that’s before any leverage is put to work. As we have hopefully learned, the credit machine feeds the buyback machine, and away we go. Tack on the prospects of a Republican Congress facilitating the repatriation of all that offshore cash and you’ve got the makings of a true buyback renaissance. Oh, and by the way, a seriously overvalued bond market.

Jesse Felder, president of Felder Investment Research, recently put pen to paper to quantify the value investors get today. What sets Felder apart from the crowd, in a good way, is that he factors in the backdrop of record bond issuance feeding what had, until very recently, been a record pace of share buybacks.

“When you look at corporate valuations more comprehensively, including both debt and equity, we have now matched that prior period,” Felder wrote in a recent report, referring back to peak dotcom bubble valuations. To arrive at this conclusion, he compares the value of nonfinancial corporate debt and equity relative to gross value added, an effective gauge of enterprise value-to-sales.

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Disclosure: None.

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