Trevor Cooper FCISI
Naisbitt King Bond Market Commentary 1st February 2022
Welcome to 2022
Raising interest rates this year
Heavy new investment grade issuance for the start of the New Year
Slow start to high yield new issuance
Braskem and Oracle upgrades
Christmas present for Apple with upgrade to the top rating
Welcome one and all to our first Naisbitt King Monthly Bond Commentary of the new year. The threats of the pandemic, higher inflation and high interest rates have now been joined by a threat of a Russian invasion of Ukraine. We have seen U.S inflation reach 7% and the UK at a 30 year high of over 5%. Reaction to this has been mixed. After the shock of the inflation numbers, sovereign bonds headed south. The yield on the U.S. 10-year travelled 10bps higher but very soon retreated to its current 1.78%. Of course, this is much higher than the 1.50% yield at the start of the year. The Treasury curve has flattened as investors believe the Federal Reserve will raise short-term rates. In equities the Footsie is up 0.9% this year but the American S&P 500 is down 5% and German DAX 2.6%. As Alastair said in his Chairman’s Letter, interest rates have been predicted to move higher this year but nothing the market hasn’t foreseen. Our own best guess is that the 10-year Treasury bond will reach 2.25% this year as the Fed raises rates with progressive increases. Credit fundamentals remain strong although there will surely continue to be challenges ahead. We expect interest rates to rise modestly in the U.S. and UK over course of 2022 and 2023, but much has been discounted already.
Our investment strategy for the year will be to continue our winning formula of cautious and flexible investing which saw our client portfolios returning increased capital and solid income returns. All our client portfolios have beaten market respective benchmarks, including the PIMCO Total Return fund. This success came from a combination of low risk, investment grade investments and elevated risk high yield holdings. With our well diversified credit portfolios, long-term investors will continue to be well-paid for any risk they are taking. It was comforting to see that at no time during in pandemic did we see evidence of higher levels of default rates which ended 2021 at 1.2%, an all-time low – we believe this situation will continue this year. Some market-watchers are now predicting a zero level of failures in BB companies this year. Over the last couple of years many companies have taken the opportunity to de-lever and increase the duration of their balance sheets. Predications for ratings upgrades to investment grade this year are also high. Questions for us this year include how much is priced in for concerns of inflation, supply chain issues, energy prices and shortages, and the Russian aggression.
This year we will continue to explore and research where to be fully weighted and what sectors and companies to avoid. As in 2021, we will run a somewhat overweight position in banks and other financials, particularly at the subordinated junior debt level of globally significant banks, which give the appropriate risk/reward. We believe banks and insurance companies will continue to prove resilient throughout this year, as they were in 2021. They are more immune to inflation rises than many other industries and can actually benefit from increasing rates.
Our preference is still for bonds denominated in U.S. dollars and sterling. For this year we will be looking at cyclical companies. Besides banks, this would include chemical and construction companies but also could include, if we see an appropriate opportunity, motors and airlines. Naisbitt King Asset Management’s research, flexibility, and preparedness to react will always be essential to the efficient running of our portfolios.
Netflix gains top rating
After the 4th quarter figures were announced a couple of weeks ago, Netflix shares seriously dropped and are now down 30% since the beginning of year, but its bonds have only fallen modestly. The media company reported better-than-expected earnings for its fourth quarter a couple of weeks ago but issued weak subscriber growth forecast for the first quarter which spooked investors. Several analysts downgraded its shares following earnings report. So far, the ratings agencies haven’t moved. Netflix is rated Ba1/BBB positive/stable. Interestingly independent American rating agency Egan-Jones upgraded Netflix one notch, after the latest figures, to BBB. For us Netflix bonds have always been too expensive, and have never held them.
New issues for 2022
Financials were the first out of the blocks for the new year this year with names such as Blackstone Finance, MetLife, Bank of Nova Scotia, Santander, Credit Agricole, UBS, Deutsche Bank, Toronto Dominion Bank and Standard Chartered all successfully borrowing large amounts of cash in the first couple of days. In euro’s, we saw BPCE, Sabadell, Barclays Bank and Banco Bilbao. How did investors react to these offers? The answer is very well, covers were high and after-market prices increased. Even the pace of sterling denominated issuance, which was at a very low level last year, increased this year with Banco Bilbao, National Bank of Australia, Lloyds, New York Life and Yorkshire Building Society all launching debt in the currency.
The frenetic pace of issuance in the year’s first week has continued, albeit at a slower pace and now total investment grade dollar issuance in January has reached the second highest on record at $142bn, a 43% rise compared to last years $95.9bn. Europe’s debt market is also breaking records with $221.75bn worth of European bond sales achieved so far this year. By contrast the high yield market had a rather dull start to have it’s worst January on record. The first issue did not appear until the second week with a $550m deal for job search company ZipRecruiter. Last week there was a slowing of investment grade dollar issuance ahead of the big bank’s reporting season.
Braskem raised to investment grade by Fitch
Brazilian petrochemical company Braskem SA saw its long term rating was upgraded to investment grade level by Fitch just before Christmas. The rating agency assigned the company’s senior level notes to BBB- stable, from a non-investment grade BB+ positive. Fitch said that the ‘upgrade reflects the material improvement Braskem made to its capital structure by paying down $1.7bn of debt with excess cash flow generated during the top of the petrochemical cycle. The company's credit ratios should remain at or below 2.5x in the medium to long term despite an expected deterioration in spreads’. In September S&P also upgraded Braskem into its investment grade territory with its own BB+ rating lifted to BBB-. Unusually for bonds that have crossed into investment grade level Braskem’s bonds have underperformed, with wider spreads.
New Year ambition for Oracle
In December, Oracle Corp agreed to acquire medical-records systems provider Cerner Corp. for more than $29bn, a deal that would add a broad customer base in the health-care industry to bolster the software maker’s cloud-computing and database businesses. The all-cash transaction was Oracle’s biggest-ever deal. In March last year, Oracle successfully raised $16bn for debt buybacks from an orderbook of over $35bn, so the company’s access to money has not been a problem in the past. However, the Cerner Corp deal wasn’t liked by the rating agencies Moody’s, S&P and Fitch all put their Baa2/BBB+/BBB+ senior ratings immediately on negative watch. Thoughts for the Cerner deal revolved around the increased leverage and a meaningful deterioration in cash balances. Although we do not believe that Oracle will lose its investment grade status, its ratings could be downgraded one notch. Its bonds have underperformed since the announcement. It’s 10-year dollar bond has widen +30bps with a 4 point price loss. Cerner has very few bonds in issue and is not rated.
Christmas joy for Apple
Before the Christmas celebrations Apple had reasons to be cheerful when Moody’s upgraded the company to the rare Aaa rating level, the first time in the company’s history, with a stable outlook. Moody’s said the upgrade reflected the ‘company’s exceptional liquidity, robust earnings that we expect will continue to grow over the next 2 to 3 years, and it’s very strong business profile,’ Moody’s also said ‘Apple’s ecosystem of products and services provides enhanced revenue visibility over time despite some level of volatility that is inherent in its business from product introduction cycles’. It should be remembered Apple was rated just B1 22 years ago. Apple’s shares are trading near their all-time high. S&P has had their AA+, stable, rating on the company since 2013. Apple last launched bonds in July 2021 when they raised $6.5bn with 4-part deal. Despite the upgrade Apple’s bonds have underperformed. For example, the 10-year tranche of last July’s deal was issued of a spread of +47bps but is now trading at +66bps with the price dropping almost 6 points.
Morrisons disappearing bond issue
In our last Bond Commentary of 2021, I wrote that Morrisons had postponed a debt offering due to market conditions. The week after I sent the Commentary, the market discovered the reason – it lost its long held investment grade rating. Moody’s downgraded their ratings sending the company straight to sub-investment level downgraded their rating 2 notches to Ba1, watch negative. Moody’s said it considers governance risks in the assessment of Morrisons’ credit profile will mean the company will likely maintain relatively high leverage. Morrisons’ said its rating will be no higher than Ba1 and is likely to be lower depending on the mix of debt and equity of the ultimate financing of the transaction. Morrisons will not attempt another bond issue any time soon. In October last year, Morrisons was taken over by American private equity company Clayton, Dubilier & Rose for £7bn.
Trevor Cooper FCISI
Chief Executive Officer
Chief Investment Officer