Individuals have debt cycles that coincide with macroeconomic issues and monetary policy. While these are the drivers, the average American really only focuses or knows one thing; interest rates. Life choices are made more difficult as rates rise. That new car or house that was on the horizon has become more difficult to afford.
This premise is also true in the corporate bond market, which after all, is made up of individuals. The market cycle for corporations also fluctuates. All we are really referring to is the cost of money. Typically, when the cost is low, or perceived to remain low, corporate borrowing will increase, and vice versa. According to David Oliphant, an executive director at Columbia Threadneedle Investments, “We’re getting to the end of a very protracted and mature credit cycle.”
High yield bond king Michael Milken will take us down memory lane with his quote, “Everything starts out as junk.” He puts trade in an interesting perspective. “When things started coming from Japan in the 1960s and 1970s, everyone said they were junk. And then all of a sudden we felt by the 1980s the quality of their products and cars was better. Everything coming out of China was junk.” Companies can finance growth in two ways; debt or equity. Milken will tell you that the junk bond market created some 60 million jobs during his tenure in the corporate bond world. These are companies that would not otherwise have access to investment grade credit, but ultimately turn in to success stories such as Uber Technologies Inc., Tesla Inc. and WeWork Cos.
The current economic climate is one in which companies are finding it harder to issue debt, both investment grade and junk. In what seems paradoxical, the month of October saw money flow into bond funds and out of equity funds. Investors withdrew $3.1 billion from investment grade corporate bond funds last week, according to Bank of America Merrill Lynch, bringing outflows over the past two months to a record $25.2 billion. High yield funds have also seen big withdrawals. By contrast, equity funds drew in $8.5 billion last week despite stocks falling. Much of the hype is focused on the equity side with slowing global growth and the constant fears of a trade war, and rightly so. Don’t forget the other side of the equation. Less cash flow also reflects on a company’s ability to repay debt. Credit markets had also benefited from a decade of monetary stimulus that is now being withdrawn. In addition, the European Central Bank is ending its bond buying program and the Fed is raising interest rates and winding down its balance sheet. On a positive note, many companies locked in their borrowing needs in early 2018 anticipating that the debt market would move against them. It’s all about the spreads and the direction they will head.
The same factors that have pressured this market are still there, including slowing global growth, less monetary stimulus and concerns over trade. According to Wolfgang Bauer, co-manager of the Absolute Return Bond Fund at London-based M&G, “Credit is entering a new regime and transitions tend to be difficult.”