Price Lock

Price lock.  Stocks closed slightly lower as traders took in Powell’s comments and a rush of mixed earnings announcements.  

Inflation is still nowhere to be seen and traders view that as a positive… for now.

N O T E W O R T H Y

Junky choices.  If you were looking for some newly issued bonds yesterday, your choices would have included $8 billion worth of risky, high yield debt which was up for the offer. Carnival Corp, still struggling to keep its ships righted, if not floating, has obviously been devastated by the pandemic as leisure cruising has ground to a halt.  Though recent signs of improvement are encouraging, many analysts are concerned that a full recovery in that industry is going to take some time.  Still, the company needs to pay bills, and raising cash in the bond market seems to be a viable option in this still-low interest rate environment. Yesterday, Carnival offered a 5.75% B+ rated bond that will mature in March of 2027.  A bond that pays almost 6% seems pretty good these days, doesn’t it?  Well, let’s see about that.  We will get back to the health of the company at some point, but let’s start with some bond basics.  First off, the bond was offered at a +510 basis point spread to US Treasuries. What that really means is that an investor is being paid roughly 5% to take on the risk that the company may miss interest payments or even fail to repay your principal at maturity.  US Treasuries are considered risk free, and a similar maturity treasury ( 0 5/8% 3/27) only yields around 65 basis points… that is 0.65% in regular terms.  If you buy 1 bond for $1000, you can count on receiving your coupon payments of $3.13 twice a year until it matures, at which point, you will get your $1000 back.  Doesn’t seem very appetizing, does it?  If you bought the new issue Carnival bond, you would hope to receive $57.50 a year until they either get called in 5 years or they mature in 6, at which time, you hope to get back your $1000.  Notice how I used the word “hope” in the past statement.  Of course, you have to do your homework on any investments you choose, no matter how risky, but in the case of bonds, many rely on credit rating agencies to do some of the heavy lifting… as a starting point. This bond in question has been given a B+ rating by Standard & Poor’s.  While you would probably be thrilled to get a B+ in advanced Calculus, this grade has a very different implication for a bond. According to the company’s rating system, and I quote “An obligation rated ‘B’ is more vulnerable to nonpayment than obligations rated ‘BB’, but the obligor currently has the capacity to meet its financial commitments on the obligation.  Adverse business, financial, or economic conditions will likely impair the obligor’s capacity or willingness to meet its financial commitments on the obligation.”  Wow, that doesn’t sound very reassuring, does it?  According to the rating agency, the company can afford to borrow it, but if things get tough they may not be able to pay you… or they may not be “willing” to pay you.  When it comes to ratings, anything below BBB is considered speculative, as investment grade which runs from AAA (the least risky) through BBB. Ratings go as low as D, and BB is the least risky of the speculative grade, so the Carnival bond issued yesterday is not the most risky, but also not the least risky of the speculative spectrum.  Ok, so now you know that you are getting a whole 5% more in coupon payments just to take on that risk… as graphically described above.  Another question you might ask yourself would be “is 5% enough of a premium for that type of risk?”Well, if we look back at historic spreads, or risk premia, of B-rated corporates in various maturities, we can see them spike as high as 18% during the financial crisis and trending ever lower since, leaving them near their all-time lows. That can be interpreted that investors are less concerned with risk than in the past.  Hmm. Combine that with the record-low interest rate environment, and you get very little return for taking on risk.  Carnival has issued 15 bond offerings since the onset of the pandemic, more than doubling its total debt since 2019.  The company had sales of just $66 million in the last 2 quarters of 2020 compared to the $11.4 billion it had in the same 2 quarters of 2019.  So, it is clear that bond investors are speculating that the company will remain at least as healthy as they are today for the next 6 years. Speculators in the stock lost -59% since the beginning of 2020 through current.  If you want to take a little less risk, you may want to check out yesterday’s bond offering from Centene, a healthcare provider.  Yesterday, they issued a 10-year maturity bond with a BB+ rating, just on the cusp of speculative grade, with a record low 2 1/2% coupon. That is $25 a year for 10 years. Not excited about that?  I am sure you are not.  Investing in bonds these days is a challenge in which investors have to weigh the tradeoffs between return on capital and the return of capital. With yields so low, the task becomes that much more difficult. It is no wonder that so many investors who historically bought bonds are now shunning them for investments in stocks… which bear a whole different set of risks.  

THE MARKETS

Stocks had a lower close yesterday but investors were encouraged by a lower-than-expected inflation figure.  The S&P500 slipped by -0.03%, the Dow Jones Industrial Average advanced by +0.20%, the Russell 2000 Index fell by -0.66%, and the Nasdaq Composite Index gave up 0.25%.  Bond climbed and 10-year treasury yields slipped by -3 basis points to 1.12%.

NXT UP

– Initial Jobless Claims (Feb 6) is expected to come in at 760k, down slightly from last week’s encouraging 779k.  I say encouraging because it has trended down a bit.  The actual number is still stubbornly high.

– Continuing Jobless Claims (Jan 30) is expected to come in at 4.42 million compared to the prior week’s 4.592 million.

– This morning, PepsiCo, YETI, Generac, Virtu, Laboratory Corp, Kraft Heinz, Tyson Foods, BorgWarner, and Duke Energy beat estimates while Molson Coors, and Kellogg missed.  After the bell announcements will include Digital Realty Trust, Seagen, GoDaddy, Illumina, Datadog, Chemours, DaVita, HubSpot, and Expedia.