As markets prepare for the Federal Reserve announcement Wednesday, the rout in high-yield credit markets has become a primary risk focus for investors. Last Thursday the announcement that Third Avenue Management would have to take the highly unusual step of limiting redemptions among investors in a distressed-debt mutual fund as the portfolio was liquidated rattled broad market sentiment. The news was followed by the announcement that London-based Lucidus Capital Partners would be returning all capital to investors from its high-yield focused hedge fund. As a combination of increased default fears in some sectors, notably energy, and light liquidity in the broad lower-grade credit segment have driven spreads higher sharply many investors of all classes have withdrawn from the pursuit of yield. With the Markit CDX North American High Yield Index at its highest level since 2012, it appears likely that this retreat will continue.
Eurozone industrial production rises. Data released by Eurostat on Monday brought positive news for the European manufacturing sector with the headline industrial production index for the common currency region climbing by 1.9 percent from the same month last year in October. Almost all segments improved including modest increase in energy production.
International climate accord reached. The 21st Conference of Parties United Nations climate negotiations in Paris ended in a historic agreement among more than 190 countries to work towards limiting global warming to 2 degrees Celsius globally. The agreement, which will go into action in 2020, will require developed economies to contribute $100 billion annually towards the initiative with a total estimated cost of $16 trillion.
Uber presents new contract to limit suit risk. On Friday San Francisco’s Uber Technologies unveiled a new contract that restricts the ability of those who sign to take legal actions against the ride-sharing company. The move comes just days after a federal court ruling allowed a class-action suit over employee status to expand to as many as 160,000 drivers. The new contract was criticized by legal counsel representing drivers in the suit. Despite the company’s legal woes, its most recent valuation has been estimated at as much as $70 billion.
Leveraged ETFs come under fire from SEC. On Friday the Securities and Exchange Commission issued a proposal to limit leverage within the underlying net assets of exchange-traded funds (ETFs) to 150 percent. Highly leveraged ETFs investing in derivative products account for more than $30 billion in assets. Although this represents a tiny fraction of total assets in the ETF market, regulators have been critical of providing retail investors access to these potentially volatile products.
Chinese industrial production beats forecast for November. Data released by China’s National Bureau of Statistics over the weekend revealed that total industrial production rose by 6.2 percent in November versus the same month in 2014. The gains did not include improvements in all segments, however, with steel output declining to slightly more than 63 million metric tons in November, a 1.6 percent year-over-year contraction.
National Front fails to make gains in French election. Poll results on Sunday indicated that the far right-wing National Front party won no regional assemblies in a runoff election despite gains in the initial round of voting. Both party leader Marine Le Pen and her niece Marion Marechal Le Pen lost out to Republican candidates in separate regional runoffs. The National Front, a Eurosceptic party which has proposed anti-immigrant policies, was forecast as a potential big winner in the wake of the recent terrorist attacks in Paris.
Consumer brands megamerger. Atlanta, Georgia-based Newell Rubbermaid announced Monday an agreement to acquire Jarden Corp., headquartered in Boca Rotan, Florida, in a transaction valued at roughly $13 billion in cash and equity. The merger would see a broad range of iconic consumer brands including Mr. Coffee, Sharpie and Rubbermaid under one corporate umbrella.
Atmel backs off from Dialog Semi deal. San Jose, California-based Atmel Corp. announced that it has received an unsolicited bid that exceeds the offer made by U.K.-based Dialog Semiconductor tentatively accepted by Atmel’s board in September. Atmel makes semiconductors with a specialization on microcontroller systems.
Consumer brands mega-merger. On Monday Newell Rubbermaid announced an agreement to acquire Jarden Corporation in a transaction valued roughly at $13 billion in cash and equity. The merger would see a broad range of iconic consumer brands including Mr. Coffee, Sharpie and Rubbermaid under one corporate umbrella.
Portfolio Perspective: Not Much “New” News Sending Markets Lower
Friday’s key market drivers—crude oil, the yuan and U.S. high-yield bonds—are all significant and are likely to carry important implications into the new year. However, we do not see as much “new” in these stories as the markets did. And we believe that a bias toward year-end tax-loss selling in equities and a general desire to liquidate losing positions ahead of December 31 greatly contributed to the sensitivity of the markets to bad news.
As dispiriting as it may be for investors to see crude oil again hit multi-year lows, is it really surprising? It is clear that the huge drop in prices this year has not been enough to adequately reduce production. Prices have to move lower to do so. Although prices are oversold, the downtrend has been relatively orderly and we have not yet seen an exhaustion bottom. We could easily be heading for a test of the December, 2008 low of $32.60 sooner rather than later.
As we have noted before, U.S. stocks have trended higher the past two years even as crude oil prices have plunged. So we do not see longer-term bearish implications for equities unless commodity prices completely collapse.
Regarding China and the yuan, we completely agree that the currency will weaken and increase global deflation pressures. But we view China’s move to create a multicurrency basket to measure its currency against as reflecting already existing pressures and developments rather than representing a policy change. More mature and developed currencies should not be pegged to the dollar, and market forces are the ones that are pushing for a weaker yuan. The multi-currency basket news did draw more international attention to the underlying fundamentals but really affected market psychology more than anything else.
As for the high yield U.S. bond market, there are clear bearish pressures at work. And the risks to the economy are there if these continue to intensify. But energy credits represent the vast majority of the problems, the sector is heavily oversold, and Third Avenues difficulties largely reflected over-concentration of risks. If the problems spread to the investment-grade sector, then the risk of recession will escalate. But this has not happened yet. So while high-yield bonds may face further pressures in coming months, we are not yet at a stage where contagion is likely.
The coming week is probably the last one for investors to get out of positions in any meaningful size as market liquidity will probably worsen significantly for very long after the FOMC policy announcement on Wednesday. This should greatly reduce the risk selling soon and cause speculative shorts to get covered ahead of year-end and early January when cash flows for equities should turn positive. And if the current round of market developments lead to an even slower pace of Fed rate hikes in 2016, risk-asset markets should receive comfort.
Karl Haeling is a vice president at Landesbank Baden-Württemberg in New York.
