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Companies are selling bonds like madmen. This year through Tuesday,
investment-grade and junk-rated companies have sold $438 billion in new
bonds, up 14% from the prior record for this time of the year, set in 2013,
according to Dealogic. This quarter is already in second place, nudging up
against the all-time quarterly record of $455 billion of Q2 2014.
About $87 billion of these bonds funded takeovers, a record for
this time of the year, the Wall
Street Journal reported. The four biggest bond sales in that batch were
for healthcare takeovers, including the Actavis deal whose $21 billion bond
sale was the second largest in history, behind Verizon’s $49 billion bond sale
in 2013.
Actavis had received orders for more than four times the bonds
available, according to CFO Tessa Hilado. “You don’t really know what the
demand is until people start placing their orders,” she said. “I would say we
were pleasantly surprised.”
Brandon Swensen, co-head of U.S. fixed income at RBC Global Asset
Management, couldn’t “see anything on the radar that’s going to slow things
down materially,” he told the Wall Street Journal. His firm expects rates to
“remain low.”
All of the investors chasing after these bonds expect rates to remain low.
Or else they wouldn’t chase after these bonds. If rates rise, as the Fed is
promising in its convoluted cacophonous manner, these bonds that asset
managers are devouring at super-high prices and minuscule yields are
going to be bad deals. And their bond funds are going to take a bath.
But companies are selling bonds as if there were no tomorrow. They’re
thinking that rates will not remain low. They’re trying to get these things
out the door cheaply while they still can. They’re on a feverish mission to
take advantage of these ludicrously low rates while they’re still available.
And they use this cheap money to buy each other and to repurchase their own
shares to pump up share prices and max out executive compensation packages,
rather than investing it in productive activities.
So is the Fed giving split signals?
Corporate issuers interpret these signals to mean that this won’t last,
that they need to sell as much cheap debt as possible before rates rise, perhaps
sharply. But bond fund managers interpret these signals in their own way,
lulling themselves into thinking that rates will stay low forever.
One side is misreading the Fed’s signals. Perhaps bond fund managers don’t
care; all they have to do is be as good as the market. And when rates go up,
the entire market takes a beating, and bond fund managers individually can
hide behind that.
But what happens when investors in these bond funds figure out that their
bond fund managers had taken the wrong side of the bet, that corporate
issuers had known all along what bond buyers had closed their eyes to
– rising rates falling bond prices – and now they’re trying to unload
their bond funds?
When bond funds face these kinds of redemptions, they first plow through
their cash, then they try to sell the more liquid bonds in their fund, such
as Treasuries, and if that isn’t enough, the less liquid bonds.
But liquidity is a funny thing: it evaporates without notice, just when
you need it the most.
Liquidity gives you the ability to sell something without having to slash
the price. When no one wants to sell and when you don’t need liquidity,
there’s plenty of it. But when you really need liquidity to sell something
because you see something worrisome, then everybody else sees the same thing,
and they too need to sell. Buyers, who also see the same thing, disappear.
And liquidity just evaporates.
It doesn’t mean you can’t sell. It means you have to slash your price to
sell. Everyone has to slash their prices in order to lure buyers out of
hiding. And worse, as prices get slashed in a highly leveraged market, margin
calls go out, hedge funds get nervous, and leverage begets forced selling.
And prices drop further. But this leverage once provided liquidity, and
now it doesn’t go anywhere else and doesn’t shift to other assets, but gets
paid off. It too just evaporates.
That’s the dynamic of market mayhem.
After six years of global QE and interest rate repression, absurdly
inflated valuations – from government bonds with negative yields to junk
bonds with ultra-low yields – have become the norm. But liquidity has become,
to use the Bank of England’s expression, “more fragile.”
Last week, the Bank for International Settlements rang the alarm bells on
liquidity, fretting that bond markets have become vulnerable to these sorts
of shocks. And yesterday, the Bank of England Financial Policy
Committee released the statement
of its March 24 meeting that was jam-packed with warnings about “market
liquidity risks” – and potential “sharp adjustments in financial markets.”
It cited the Treasury flash crash last October as an example of when
liquidity even in the supposedly most liquid of bond markets – US Treasuries
– just evaporated. As it said, “sudden changes in market conditions can occur
in response to modest news.”
And it frets: “investment allocations and pricing of some securities may
presume that asset sales can be performed in an environment of continuous
market liquidity, although liquidity in some markets may have become more
fragile.”
Not that central-bank warnings have any impact on investors. They’re too
busy chasing yield. And thus government bond yields continue to bounce along
near zero, or below zero. High-grade corporate bond yields are so small
they’re barely discernible. Junk-bond yields show that there are few risks
out there, even for the riskiest companies in the riskiest sectors. It has
taken central banks six years to blindfold investors to risk, and now
investors have become addicted to these blindfolds and simply don’t want
to take them off. But when they do, possibly all at the same time, they’ll
find out that the liquidity they thought would be there for them has
just evaporated.
In the American heartland, real businesses are already getting nervous.
“We don’t see the economy being as strong as portrayed in the national
media,” the Kansas City Fed quoted one of them. Read… You
Should See the Reasons Cited for the Plunge of the Kansas City Fed
Manufacturing Index
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