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Posts from the ‘Fixed Income’ Category

Europe Changes Its Tune on Growth vs. Austerity

Oh dear. Reinhart and Rogoff may wish to avoid ever holidaying in Greece, Portugal, or Spain. Their seminal (and now-disproved) paper – arguing that once a country’s public debt was over 90% of their GDP, there is a strong negative relationship with the country’s economic growth – probably took up a fair amount of the Troika’s discussion time when it was deciding on the measures the peripheral countries needed to take if aid were to come their way.

Of course, Reinhart and Rogoff were not the only ones to argue that high government debt is bad for growth. Over the years, several economists have pointed out that government borrowing can crowd out private investment, and that reducing government borrowing can allow growth to resume.  Read more

Investing is all About Riding the Bigger Bike

From the desk of risk:

The trader sums his gains.  The investor compounds her returns.

When I was a kid, we used to have bike races through the neighborhood.  One particular race on a summer evening featured a 1.5 mile route, a fit 12-year-old on a dirt bike, and a slightly pudgy 10-year-old on a ten-speed.  Of course, the ten-speed was a much bigger bike so it was going to be an interesting race. Those not racing would follow along on their bikes or wait at various points along the route.  A few bets were made (mostly trading cards) and the race was on.

The race began exactly as would be expected – the older boy on the smaller dirt bike jumped out to an enormous lead. At one point, the distance between the two riders was somewhere between two to three hundred yards.  But . . . slightly past the halfway point, the younger boy on the ten-speed pulled ahead. In the end, it wasn’t even close. 

Why did the younger boy win?  Read more

Concrete Concepts for High Yield Research: Part 2

Last week, I introduced the idea of ten concrete concepts that our high yield research team uses to help summarize the many interacting factors and variables that make high yield a unique and challenging asset class. In my previous blog post, I covered the first five: cash flow, capital, cushion, cyclicality, and competition. To finish up this thought, here are the last five:

  • Cost Structure – A company can’t provide products and services to customers without incurring some costs. Within a particular sector, many companies face similar cost pressures, but not always. For instance, there is a currently great disparity between the cost of natural gas in Europe (high prices) and in the United States (low). This has created a tremendous opportunity for companies in the chemical sector that use natural gas as an input to their production process.
  • Read more

Concrete Concepts for High Yield Research: Part 1 – The Fixed Income Perspective

Investors looking for yield face a challenge in the current market environment. With many of the world’s major central banks engaging in quantitative easing, sovereign debt yields are at or near historic lows. That drives fixed income investors to look at bonds with lower credit ratings, specifically non-investment grade bonds, or more appropriately, high yield. That demand is being met by new supply. In fact, March saw U.S. high yield volume reach US$34.9 billion. That’s the highest monthly output since October of last year. However, high yield isn’t an asset class where an investor should just wade in and buy up whatever supply hits the street. Investing in high yield requires rigorous research, and as the head of Principal Global Fixed Income’s high yield research, I’ve found that it’s useful to keep in mind ten concepts that help summarize the many factors and variables that interact to make high yield unique and challenging. Here are the first five:

  1. Cash Flow – Cash flow is important to everyone, but it’s critical in high yield investing. We look at cash flow as the life blood of a company. It is what is left after a company sells its products and pays the costs to produce and sell those goods. Read more

The Great Debate on the Great Rotation: The Fixed Income Perspective

There have been many classic debates in popular culture over the years.  In technology we’ve had PCs versus Mac, and then Droid versus iPhone.  In beverages, we’ve had Coke versus Pepsi, while in entertainment we’ve suffered through Team Edward versus Team Jacob.  And baseball will always have the Red Sox versus the Yankees.  Even in investments, we have had our own ongoing version of a great debate, which has been simmering for a few years, yet this one involves asset allocation and is much more meaningful and significant:  will there be a “great rotation” out of corporate bonds into equities?  Read more

European Haircuts – The Latest Styles from Cyprus and Greece

According to GQ, the hottest haircut trends for 2013 are things like the slick comb over, the short crop, the medium and messy, and the long and parted. Cyprus and Greece have been going a different path; pioneering haircuts that have investors around the world feeling jittery. And by “haircut,” I mean “writedown,” or “loss.” On Saturday, the tiny island nation of Cyprus announced it would raise about €5.8 billion by taxing bank deposits – including individual deposits with only small account balances. This proposal is a means of easing the pain of a bailout agreement. The announcement, which hasn’t stated specific thresholds or percentages, sent a shudder of panic through Cypriots and the wider investment community. Originally, the plan called for a 6.75% tax on amounts less than €100,000, and 9.9% on amounts over €100,000. That means if you had €1,000 in your bank account, after the tax, you’d miraculously lose €67.50.  The problem with all of this for investors is not the scope for financial contagion to other periphery markets; the Cypriot economy is relatively small – somewhere around US$25 billion, according to the IMF. No, what has investors spooked is the implication of the bank-deposit haircut. Read more

Moody’s Downgrades the UK: Keep Calm and Carry On

If you want Aaa-rated government debt, you’ll have to go looking to Canada, or Australia, or Germany, because late last week, ratings agency Moody’s officially downgraded the United Kingdom’s government bond rating from Aaa (their highest level) to Aa1 (their second highest level). Moody’s downgrade was based on three factors: the UK’s weak medium-term growth outlook; the impact of the weak economic outlook on the government’s fiscal consolidation plan; and the high and rising public debt burden. On the last point, Moody’s expects debt to peak at over 96% of GDP in 2016.

The downgrade wasn’t really a surprise, but it did come earlier than expected. The Office of Budget Responsibility had projected that government debt would remain over 90% of GDP for at least six years – that’s inconsistent with a triple-A rating. However, the downgrade came before the official budget was announced on March 20, which is when most figured the nudge downward would have come. Read more