While the news media has been commemorating the 5 year anniversary of the financial crisis, investors continue to vacillate between risk-on/risk-off strategies on a daily basis. September was especially so, driven by a barrage of “you gotta be kidding me” news headlines.
To recap, Verizon announced and within 48 hours completed the largest corporate bond deal ever; nervous investors grappled with the impact of the Federal Reserve’s impeding change to monetary policy; Democrats and Republicans continued to disagree on the future of “Obamacare,” budget funding, and raising the debt ceiling; terrorist tragedies shattered the lives of innocent people at the Navy Yard office building in Washington D.C. and a mall in Kenya; Federal Reserve Chairman Bernanke shocked the capital market by reversing course and continuing the current program of quantitative easing; several members of the Federal Open Market Committee, namely Dallas Fed President Fisher, publicly blasted the reverse as being irresponsible; and finally, despite expectations to the contrary, Federal Offices are closed at the time of this writing due to Washington’s inability to agree on budget funding.
Given the lengthy list of market moving events, the bond market was remarkably stable for the period. The most economically surprising event was Chairman Bernanke’s announcement that the Federal Reserve was not yet prepared to slow the quantitative easing program. Since the idea of tapering the program was initiated in May, members of the Open Market Committee have consistently signaled that the program would begin to wind down at the September FOMC meeting. Taking the cue from those pronouncements, investor consensus was nearly unanimous that the taper would occur in September and that the amount would total between $10 and 15 Billion. While the stock market reacted negatively when the plans were first announced in May, equities had stabilized at levels just below where indices traded prior to the announcement. One would think that with the message well communicated and capital markets fully prepared for the taper, the Fed would follow through with their plan. However, during the post-meeting press conference, Bernanke explained that conditions were not right for them to justify the action. With that, euphoria returned to the stock market as all major indices rallied sharply higher on the news of the continued flooding of the money supply. Perhaps Bernanke and the members of the Open Market Committee believed that a reduction in easing would worsen capital markets just before the debt ceiling debate. Certainly, as the newest debt ceiling deadline approaches, markets are again showing signs of nervousness. Nonetheless, with the market in equilibrium and the Fed regaining a modicum of credibility with the anticipated decision, the reversal made little sense and, arguably further damaged the credibility of the Central Bank. Certainly, Richard Fisher, the President of the Dallas Federal Reserve was not happy about the about-face.
Perhaps best highlighting the relative calm in the market over the last month was Verizon’s pricing of $50 Billion in corporate debt. Verizon agreed to pay Vodaphone $130 Billion to buy the 45% of Verizon Wireless that it doesn’t already own. The purchase will conclude a 14-year, oft times contentious, joint-venture between the American and British Telecommunication companies. Verizon decided to fund the purchase with a mix of corporate bonds, loans, and stock. The initial talk was that new debt would be offered at a significant concession to secondary market prices and in the amount of $30 billion. Demand for the new issue was robust and to such an extent that the underwriters were able to sell the entire $50 billion float at better than expected rates. We did not participate in the offering and remain skeptical of the value. From a credit perspective, the debt further gears the already highly levered Verizon balance sheet at a time that Verizon is facing a capital expenditure build out that is likely to register $20 billion this year. Should the carrier fail to deliver anything other than “as expected” results, the bonds could be at risk of a fall in price much greater than the commensurate yield-to-maturity offered. Recall that earlier this year Apple set the record for corporate new issuance with an $18 Billion deal that was met with robust demand, only to find the bonds falling sharply in price when operating results began to weaken. We fear Verizon is at risk of such a reversal.
Going into the important fourth quarter selling season we are closely monitoring consumer confidence for any signs that political nonsense is weighing on the spending plans of Americans. Our baseline forecast is for continued economic expansion aided by housing, manufacturing, and continued employment gains. However, brinkmanship politics could upend that forecast and force us to reposition accordingly. Especially since the negotiations are likely to heat up again just as Americans settle in for the holidays.