These rising borrowing costs could spell trouble for increasingly debt-reliant corporations, writes Michael Arone, chief investment strategist for the State Street Global Advisors U.S. Intermediary Business Group. Debt of nonfinancial companies has soared to 45% of GDP, the highest total since the financial crisis, which could pose challenges. Higher financing costs could hurt some business models and would diminish the cash available for dividends and share repurchases, he adds.
Policy changes explain a lot of Libor’s rise. The U.S. government’s debt ceiling has been suspended until 2019, so the Treasury has been borrowing heavily to rebuild its cash balance. That balance had been run down as Washington bumped up against the debt ceiling and had to resort to tricks to keep operating.
At the same time, the Fed is reducing its securities holdings, mainly by letting maturing Treasuries roll off, which means Uncle Sam has to sell more paper to the public. Most of that increased borrowing has come at the short end of the market, which has felt the effect of climbing yields in that maturity range. At the same time, repatriation of cash that U.S. corporations have stashed overseas—and have earmarked to be disbursed to shareholders or for capex—has reduced the supply of dollars available to lend. Share buybacks are on pace for a record year, as our colleague Vito Racanelli details on Barrons.com, That’s good for stocks, but results in a higher Libor rate.
These technical factors aside, Libor could be signaling trouble, if its relationship with other rates doesn’t revert to more normal levels. George Goncalves, Nomura’s head of rates strategy, suggests “there may be something more ominous at work.”
In that regard, writes Paul Shea, strategic economist at Miller Tabak + Co., the rise in credit costs shouldn’t be written off entirely as just benign technical effects from increased Treasury issuance or the Fed’s balance-sheet reduction. Investors’ risk aversion has increased since January, based on academic measures, but has remained near historic lows, he adds in an email.
For nonacademic types, the question is what to do. BCA Research suggests that dollar-based investors can buy low-yielding foreign bonds, but reap higher yields from hedging the currency back into dollars. For instance, a dollar-based investor can garner a 3.3% yield on a 10-year German Bund (which yields just 0.53% in euros) after hedging. This isn’t something readily done by individual investors, but institutional bond managers have that option.
For those playing at home, bank-loan funds may be the best bet. A recent Focus on Funds column noted the risk of the most popular such exchange-traded fund, the PowerShares Senior Loan Portfolio (BKLN), notably the credit risk in its loans and the limited liquidity of the loan market.
As noted here previously, closed-end funds that invest in bank loans don’t have to deal with the liquidity issue because they never have to redeem shares, which trade on an exchange. In addition, their market prices remain significantly below their net-asset values, affording investors some margin of safety, plus the potential for capital gains if those discounts narrow.
Among the CEFs with the deepest discounts, the Eaton Vance Senior Income Trust (EVF) and the Eaton Vance Floating-Rate Income Plus funds (EFF) have raised their monthly dividends in the past two months, bringing their yields to the 5.6%-5.7% range, while trading at discounts over 9%. The Apollo Senior Floating Rate fund (AFT) yields 7%, and trades at an 8% discount. So, while worries increase about rising Libor, these are ways investors can take advantage of the disturbing trend.
Facebook stock closed down at $159.39 Friday, dropping 13.9% over the course of the week. The stock plummeted earlier this week, shedding about $50 billion in market cap.
“Facebook’s troubles impacted any company that has an advertising model,” Pachter noted. In December 2017, advertising made up about 98% of Facebook’s sales.
Alphabet’s Google also relies heavily on ad sales, and the search giant saw its stock drop 9.5% over the course of the week, closing at $1,026.32 Friday. Apple shares dropped 7.3%, closing at $165.09.
Netflix Inc. (NFLX) and Amazon.com Inc. (AMZN) were least affected among the tech giants this week, falling 5.5% and 4.7% respectively. Netflix shares closed at $301.07 Friday, while Amazon shares closed at $1,495.55.