January Credit Update

Monthly Commentary

February 04, 2017

Credit spreads remained firm in January as demand for spread product continued despite political headlines and record supply. Spread performance was bifurcated however as fundamental concerns in the retail sector and a slew of M&A related headlines in telecom and cable caused those sectors to underperform. Retail spreads came under pressure as announced store closings and lowered guidance for some bellwether department store names caused meaningful underperformance for several issuers. The retail sector has become quite bifurcated as traditional brick and mortar department stores face secular headwinds due to changing consumer preferences and online competition. On the other hand, sales at discounters (like WMT , TJX, COST ), home improvement stores (LOW, HD) and pharmacy retailers (WBA, CVS), have been resilient.

The Q4 earnings season is well underway with about half of the companies in the S&P 500 having reported. EPS growth thus far is up 5.95%, an improvement vs. Q3 and the second consecutive quarter of increased growth (after 5 consecutive quarters of negative growth). Energy has been less of a drag on earnings. Profits for the sector improved as commodity prices remediated and companies reduced production costs and improved execution. Sectors with the strongest Q4 earnings growth were financials, technology and utilities. Bank earnings were healthy as FICC revenues recovered (up 65% y-o-y for the Big 6) on strong fixed income trading. Net interest margins were generally flat despite the benefit of higher 3m LIBOR - offset by some FX hedging and receiver swap losses. Capital ratios remain strong, averaging 12.45% (CET1 ratio) for the Big 6 – though capital growth was flat as the Treasury and Agency holdings (in the available for sale portfolios) suffered unrealized losses due to higher rates.

S&P 500 Q4 EPS Growth

Source: Bloomberg Barclays

EPS Growth for US IG Issuers

Source: BofA Merrill Lynch Global Research

Department store sales have posted declines (blue bar)- as their share of the market (yellow line) has fallen.

Department Store Sales

Source: MS, US Census Bureau, GAFO = Sales of general merch. apparel & accessories, furniture and other

Online sales growth climbed 10%, while department stores suffered a 2% decline.

Ecommerce Sales Growth YoY

Source: MS, US Census Bureau, GAFO

Credit index performance: The index tightened 2 basis points in January, ending the month at an OAS of +116. The total return of the index was about flat (-.06%) as both Treasury yields and corporate spreads were range bound. The yield on the credit index is 3.29%, which is not far off the five-year highs of 3.58% reached about one year ago. Since that time however, spreads are 80 basis points tighter so the rise in Treasury yields has offset most of the spread tightening.

From a major sector standpoint, Sovereigns outperformed Industrials, Utilities, Financials and Munis in January and spreads have been rather stable post the election – despite all the political rhetoric. Drilling down into Industrials, performance among issuers and subsectors was bifurcated. The outperformers: The inflationary trade continued with Energy and Metals outperforming (-7 and -20 bps tighter respectively). The Energy sector OAS is now +141 bps, which is 25 bps wide of the overall credit index – in line with historical averages.

The biggest underperformers were Wirelines (+8 bps), Retail (+7) and Cable (+4). Telecom and Cable spreads were volatile on M&A headlines as consolidation in the space continues. The AT&T/TWX merger has already been announced and could bring with it $30+ billion of new debt into the market if/when the deal is consummated. Further consolidation is expected as the wireless industry looks for ways to expand services in an exceedingly price competitive industry. More vertical integration (i.e. buying cable or content) and/or wireless combinations are expected, especially if the regulatory environment becomes friendlier to those types of transactions.

The other underperforming sector was Retail, though the underperformance is attributed to a handful of department store names that widened 20- 80 basis points (KSS +80, BBBY +40). Retail has been a story of the haves and have nots, with the haves being the discounters, off-price and home improvement stores and the have nots being the more consumer discretionary brick and mortar department stores.

January Credit Index Returns

Source: Bloomberg Barclays

Investment grade issuance hit a new monthly record of $176 billion in January, comprised of $93 billion financials issuance and $82 billion non financials. Despite all the talk of an upcoming tax repatriation holiday, the two largest tech issuers came to market the past week. The first was MSFT, issuing $17 billion in debt across seven tranches. Proceeds were earmarked to pay down commercial paper, which was used to help pay for the LinkedIn acquisition. The second was AAPL, issuing $10 billion of debt across seven maturities, with the proceeds earmarked for share buybacks. While a one-time tax repatriation holiday could reduce the amount of corporate debt issuance, at least in the medium term, the timing of any tax reform is TBD. Moreover, companies need to proceed with their capital plans regardless of what might occur in the future.

The other mega deal in January was AT&T issuing $10 billion in debt across six tranches. This deal came with the largest new issue concession of the last several months, at ~ 20 basis points. Concessions were big enough to compensate investors for $30+ billion worth of supply that may come if the TWX deal goes through.

January was a record month for IG new issuance:

Source: BofA Merrill Lynch Global Research

IG Monthly Issuance:

Source: BofA Merrill Lynch Global Research

M&A related supply was negligible: 

 

Source: BofA Merrill Lynch Global Research

New issue concessions: 

 

Source: BofA Merrill Lynch Global Research

Fund flows off to a strong start:

Note: Global EM funds, US-domiciled funds only for other fund types.
Source: BofA Merrill Lynch Global Research, EPFR Global

 

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