A few thoughts on credit

Following on from yesterday's chart about the stellar performance of US high yield, Macro Man updated a number of his indicators on credit, cross asset-values, and the state of corporate balance sheets.  Did you know that 2016 is now on pace to deliver the 5th straight year of increased corporate bond issuance for the first time since SIFMA started tracking the data?


When you think about it, the reason for this is not actually very difficult to understand.   With the paucity of yield throughout most developed world markets, investors are understandably eager to buy just about anything that offers the prospect of income.   Moreover, the historical performance of US credit has delivered comparable nominal returns to equities while generating much less volatility and occupying a higher place in the capital structure.  Frankly, it seems to good to be true!


While IG is looking a little frothy recently, high yield is nowhere near Macro Man's historical danger zone (a 6m trailing Sharpe ratio of 4), and the equity market has frankly not compensated you very much for holding risk in the asset class.   Perhaps that's why it is so unloved?


It does seem perverse, however, that the asset class seeing a record amount of supply is doing so well while that seeing a shrinking supply is just muddling along.  Voici the reach for yield!  One does wonder how long the shell game of capital structure finagling can go on, however.   Between buybacks and dividends, S&P 500 corporations have disbursed approximately 120% of earnings to shareholders over the last twelve months.  On the farm, that's known as "eating your seed corn."  On a household balance sheet, that's called "living beyond your means."  In today's economy, however, policymakers seems to view it as little more than "good clean fun", common sense be damned.


Meanwhile, although they've enjoyed a brief renaissance recently, equities that have been the subject of buybacks have notably under-performed over the last couple of years.

None of this is to say that everything is going to roll over post-haste of course, particularly if the Fed somehow manages to raise rates less aggressively than they have to date in an effort to run a "high-pressure" economy.  (Funny enough, this seems like exactly what they've been trying to do since 2009, with little obvious signs of success.)

One a structural basis, however, Macro Man will keep his eye on inflation, distant as it may continue to seem.   A quasi-commitment by the authorities to allow inflation to run over target- particularly the bowdlerized version that they emphasize- would probably be the worst-case outcome for assets given the current pricing structure.  Ironically enough, that could be the trigger that catalyzes the next recession, if and when it comes.   As always, policymakers should be careful what they wish for, because they just might get it.
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Anonymous
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October 25, 2016 at 7:58 AM ×

Come on MM it hasn't been all bad! I would prefer the 2016 state of the world to 2009.

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Anonymous
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October 25, 2016 at 2:15 PM ×

MM, Re chart 2 - excuse my ignorance - has IG really outperformed HY consistently over 16yrs ?

Too good to be true indeed...

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Macro Man
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October 25, 2016 at 2:22 PM ×

@ Anon, Yes. IG index gone from 95 to 272. High yield from 97 to 252. Amazing, innit.

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Macro Man
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October 25, 2016 at 2:23 PM ×

Actually, HY is 99 to 252. Even worse!

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Anonymous
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October 25, 2016 at 2:42 PM ×

MM, if re-based post-GFC/2009, do they (IG, HY, SPX) look a little more orderly ?

BTW - Long-time-lurker (cough, piker) here - I will be a casualty of your future (understandable & 100% justified) pay-wall - so much appreciating the (advanced) education while I can !

Warm Regards, Tim

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Macro Man
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October 25, 2016 at 3:45 PM ×

Indexing the start of 2009 as 100, the Spx is 290, HY is ca. 235 and IG is 178...what you'd expect "normally"

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Andrew Crow
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October 26, 2016 at 12:31 AM ×

Oh Dear! Mr.Anonymous. I'm afraid you are a pillock. 2016 may be better than 2008 but is it better than 2006/7? When the current bubble goes 'pop' 2008 will look like a really golden age of manageable chaos.

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Mr Anonymous
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October 26, 2016 at 3:43 AM ×

We shall see.

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