All eyes will squarely back on U.S. Federal Reserve policy next week. The release of the Federal Market Open Committee (FOMC) July meeting minutes, combined with the Fed’s Jackson Hole symposium, will provide an opportunity to parse out language from Chair Janet Yellen and other committee members to detect any shifts in stance. The title of the Jackson Hole meeting itself, “Re-evaluating Labor Market Dynamics,” paints a clear picture of the Fed’s unwavering focus. Following on the heels of Bank of England governor Mark Carney’s remarks earlier this week regarding labor market structure — specifically, wage inflation — a continued dovish tone by U.S. policymakers would mark a divergence between the two largest developed economies exhibiting growth.
Reports on U.S. consumer sentiment released today. Preliminary University of Michigan consumer sentiment data is to be released at 9:55 a.m. Eastern Time. With retail spending data showing moderation in recent months, as well as mixed guidance from earnings reports in the consumer sectors, the indicator will be in the spotlight as investors try to gauge prospects for consumer spending momentum.
U.S. second-quarter earnings season draws to an end. U.S.-listed equities reporting second-quarter 2014 earnings today include New York–headquartered cosmetics company Estée Lauder and Dublin–based, NYSE-listed, industrial building materials company James Hardie Industries. The major corporate action announcement for the day is Coca-Cola’s acquisition of a $2.15 billion, 17 percent stake in Corona, California–headquartered Monster Beverage Corp. with the right to purchase up to 25 percent of the company. The move, announced late yesterday, will expand the beverage giant’s global foothold in the rapidly expanding energy drink market. Coca-Cola already distributes Monster’s products in the U.S. and Canada.
Industrial production data for July expected to show improvement. Numbers to be released today on U.S. industrial production and producer prices for last month are expected to be marginally stronger than June’s disappointing 0.2 percent rise. Bureau of Labor Statistics producer price data, also scheduled for release this morning, are forecast to register a sequential contraction from June’s levels on moderating energy costs.
Second-quarter U.K. gross domestic product growth keeps the pace. While continental Europe appears to have lost momentum, across the English Channel economic growth is gaining strength. The U.K. Office for National Statistics released today revised second-quarter numbers that showed U.K. GDP expanding 0.8 percent during the first three months of 2014. According to the report, strong growth in the service sector offset lowered revisions for industrial activity during the period. Roughly in line with consensus forecasts, this data indicate that the nation is on track to achieve the Bank of England’s annualized target of 3.5 percent for the full year.
Hong Kong signals slowing growth. In a report released today by Hong Kong’s Economic Analysis and Facilitation Unit, guidance for year-end Hong Kong GDP was lowered to an annualized range of 2 to 3 percent from a prior 3 to 4 percent target. The report cited a contraction in domestic demand coupled with weakened tourism numbers as primary factors weighing on economic activity.
Portfolio Perspective: Sizing Up Risk in High-Yield Markets — Damon Krytzer, Greywolf Capital Management
The recent market sell-off in high yield and leveraged loans has been driven by a heavy new issue calendar negative retail loan fund flows and selling by high-yield funds that were quick to sell liquid bank debt that they held in response to redemptions.
There are some indicators that have caused concern about the credit risk of leveraged loans, including above-average leverage multiples and elevated debt-to-ebitda ratios on the large end of the market, which are generally associated with leveraged buyout (LBO) lending. We are seeing leveraged loan deals that show characteristics similar to that of a late credit cycle, such as dividend recaps and higher leveraged transactions. We also see risk that default rates may rise on some of these stretched deals in the event that the economy weakens significantly. While in general investors are not being paid to take a lot of credit risk right now, we do need to consider that the current default rate by number of loans is just 1 percent compared to a historical leveraged loan default rate of 3 percent.
For exposures we prefer B/BB CLO mezzanine debt for the relatively high expected yields, structural seniority to CLO equity and positive convexity that can benefit investors in a spread-tightening environment. With conservative positioning and detailed fundamental credit work on the underlying loan collateral, there is a strong case for B/BB CLO mezzanine debt versus many of the alternatives, including direct leveraged loan exposure and especially long-duration high-yield bonds, which is arguably more exposed given a combination of interest rate risk paired with historically higher default rates and lower recovery rates.
Damon Krytzer is a managing director at Greywolf Capital Management, a New York–headquartered investment management firm with expertise in value-oriented event driven securities and CLO debt and equity. Krytzer, working for the firm from San Francisco, is also an adjunct professor at the University of San Francisco Business School.
