☀️☕️ Bonding time

📝 Focus

• Bonding time

📊 In the Markets

• US records Records; TSMC surges; HK/China’s dead cat; Japan to stay negative

📖 MoneyFitt Explains

• 🎓 Company Bonds

💸 Personal Finance Corner

• The Ultimate 101 Guide to Bonds: Everything You Need to Know

📚 Other Newsletters to Explore

• The Benchmark - High quality crypto news

• Crypto Nutshell - Get smarter about crypto

• The Money Buzz - Side hustles and online income opportunities

📝 Focus

Bonding time

The US corporate bond🎓 market is experiencing a surge of activity as companies have issued and sold a record $153bn of debt in the first three weeks of the year to eager buyers, putting the bond market on track for the busiest January this century. 

Investment-grade bonds have led the way. Borrowing costs have fallen, with investment-grade yields down to 5.34% from over 6% just two months ago, as the premium paid to issue bonds over the cost of risk-free US Treasury yields (“the spread”) sank to just 1.01 percentage points, about the lowest in the last 20 years.

Borrowers are rushing to capitalise on lower interest costs while investors seek to secure yields before anticipated US interest rate cuts later in the year.

..... ▷ Sharp-eyed MFM readers will notice that it looks like some pretty weird inconsistency in how bond issuers (the borrowers or sellers) and bond investors (the buyers) are thinking about the interest rate outlook. And they’d be right!

Bond buyers seem to be hoovering up bonds at these interest rates before they go down, while bond issuers are selling before their borrowing costs go up. 

There may be many potential reasons for this phenomenon, which in months or years to come may seem screamingly obvious (or obviously wrong). Among these are:

..... ▷ “Tourists” could be participating in the bond market. Not those with selfie sticks, but traditionally equity-oriented investors who are attracted not by spreads, duration or even credit quality (as bond investors are) but by the idea of absolute long-term returns of over 5% more safely than with share exposure alone.

For stock market investors, it is also an additional way to play the prospect of declining interest rates in 2024 and beyond (other than through the roaring stock market, where valuations benefit from falling interest rates)... especially those who missed peak levels in June 2023 and who see the recent pickup as the last chance they might have to lock in historically high interest rates before they evaporate. FOMO is not a rare behaviour for stock market traders.

(US investment grade corporate bond spreads peaked in June 2023, reaching a level of approximately 138 basis points at a yield of 6.13%.)

..... ▷ This willingness to invest translates into an attractive funding opportunity from the perspective of CFOs. 

The surge in interest rates over the last 22 months has led gearing (the amount of borrowing from companies relative to their equity base) to go up (even though interest cover, how easily they can repay the interest due, has so far stayed quite healthy.)

The opportunity to refinance their debt at lower levels into booming availability of buyers is attractive to CFOs and consistent with positioning for a potential for a recession in coming quarters, even if a recession also means lower central bank interest rates.

(Despite positive job and wage data, some leading economic indicators signal potential recessionary pressures, which the CFOs may be seeing first-hand in their own operations.)

This is because the interest rates that companies actually pay are (basically) made up of both risk-free central bank rates and a “spread,” which is determined by credit quality at the company as well as industry level, and that can be affected by a recession.

During even mild recessions, investment grade spreads tend to peak in the range of 175 to 200 basis points (1.75-2.00%.)

..... ▷ OR… with financials accounting for over two-thirds of the borrowing, it could be that overall bond issuing levels are affected not by market projections at all but by “Basel IV.”

The Basel III capital adequacy framework, finalised in 2017, is being implemented in phases globally. The final phase, known a bit confusingly as Basel IV, will be implemented in the US starting in July 2024.

Basel IV introduces stricter capital requirements for banks aimed at enhancing the financial system's resilience to potential crises. This includes higher minimum levels for Common Equity Tier 1 (CET1) capital, the most stringent form of bank capital. 

The Basel reforms began implementation on 1st January 2023 and are expected to take five years to fully implement. The changes introduced by Basel IV are significant and include revisions to the calculation of risk-weighted assets.

Perhaps not by coincidence, the surge in bank bond issuing activity also started last year, suggesting that banks are attempting to raise capital proactively before the Basel IV rules come into effect. US banks in 2023 raised bonds worth over 50% more than what they raised in 2022.

By building up their CET1 capital ratios now, they can avoid potential funding constraints (i.e. restricting banks' ability to lend and invest in the future) or higher borrowing costs later.

..... ▷ And this has led to a more competitive landscape for corporate borrowers seeking to issue bonds, as they could be facing higher borrowing costs with further increasing competition from banks as we approach Basel IV compliance in July 2024. 

(So will both bond issues and spreads fall off sharply after that?)

🇸🇬 Singapore: Let’s Get MoneyFitt!

📊 In the Markets

The S&P 500 made a record-high close, fueled by a tech rally driven by AI optimism, confirming (in hindsight) that it’s been in a bull market since 12th October 2022. 

From its previous record high close of 4,796.56 on 3rd January 2022 to what turned out (in hindsight!) to be its low that October, the S&P 500 tumbled 25%. The Friday index surge of 1.23% sent to 4,839.81. 

Nvidia and AMD rose 4.2% and 7.1%, while high-performance data centre computer maker, and hence a massive AI winner, Super Micro Computer's optimistic guidance blew through experts’ forecasts and sent its shares soaring 36%. (Terrible company name, though.)

The Philadelphia SE Semiconductor (SOX) index shot up 4% to hit a record high, while the two biggest companies in the world, Microsoft and Apple, each gained over 1%. Chip stocks have been on a renewed upswing after Taiwan Semiconductor Manufacturing reported strong demand for high-end AI chips. 

Nasdaq rose 1.70%. Despite concerns about its debt levels and survivability, Spirit Airlines rebounded 17%, while iRobot slumped nearly 27% due to potential EU opposition to Amazon's acquisition.

Earlier, Taiwan led Asia-Pacific markets on Friday, propelled by a 6.5% surge in TSMC (Taiwan Semiconductor Manufacturing Corp), the country's largest listed company by far. TSMC is twice as large by market cap (share price X number of shares) than the next 12 largest companies listed in Taiwan combined.

The positive annual forecast was driven by AI-related demand and advancements in 3-nanometer and 5-nanometer technologies, and the heavyweight share’s sharp rally drove the benchmark Taiwan Weighted Index up 2.6%. 

TSMC's positive outlook signals a potential rebound for chipmakers after a challenging year. South Korea's chipmakers Samsung Electronics and SK Hynix followed, gaining 4.2% and 3.7%, respectively. 

Meanwhile, Japan rebounded, but Hong Kong's Hang Seng index slipped 0.72%, and mainland China's CSI 300 fell 0.15% just a day after gains made on Thursday, a day that looked like just a “dead cat bounce” (when a stock or a market has a brief rally before resuming its downtrend, though a single day is so short it barely counts.)

The BOJ's first monetary policy decision of the year is due on Tuesday, with traders expecting the bank to maintain its current stance. Though Japan's headline inflation dropped to 2.6% in December, the lowest since June 2022, they think that removing negative interest rates is unlikely because of the earthquake. 

And in the UK, retail sales volumes for December plummeted by 3.2%, far worse than the 0.5% expected by The City’s Finest and more than double the drop seen in November. It was the biggest monthly decline since January 2021, when pandemic measures crushed sales and suggested a potential shallow recession in the latter part of 2023. 

Sure enough, in the bad-means-good world of stock markets (since bad news increases the likelihood of an imminent interest rate cut), London was the only one of the major European markets to close up (if only marginally.)

cords