Low Rates and Government Initiatives Power Global Markets
The strobe lights stayed on through February as cupid came and refused to leave. The S&P, TSX and MSCI World Indices registered strong gains across the board, rising 6.3%, 5.4% and 4.5%, respectively. Two political tailwinds have been cited as reasons for optimism. First, the January US Federal Reserve minutes were published which referenced a “patient” stance when it comes to further rate hikes and balance sheet deleveraging. Comments related to interest rates generally grab the headlines when the Fed issues a report. However, the markets got a shot of dopamine when it signaled that the end to balance sheet reduction would occur in 2019. Next, progress in Chinese trade talks were repeatedly awarded front-page status. On 25-Feb-19, President Trump stoked expectations for a successful conclusion to trade talks, saying he anticipated signing an agreement with Chinese President Xi Jinping “fairly soon.” This statement followed the cancellation of tariffs that were originally planned to go into effect 1-Mar-19. The import levies were slated to rise to 25% from 10%. The change would have significantly increased the trade war’s economic costs. In response to the positive developments, the Shanghai Composite soared 5.6% on a single day.
Gold continues to shine, rising 4.1% in February and a 12.3% from its low in September 2018. There has been no shortage of reasons to justify the price movement, from geopolitical concerns, central bank purchases, and perhaps most of all the continued momentum building behind governments (further) embracing debt as a tool to support public policy. Despite a swing from a US$236 billion surplus in 2000 to a US$779 billion deficit in 2018, the dire consequences of irresponsible and unnecessary spending have not appeared. Accordingly, the absence of these ill-effects is being interpreted as confirmation of successful fiscal engineering. As public policy is increasingly inclined to support a deficit, potential currency impacts could surface, which will increase the allure of gold as a store of value. Copper’s strength persisted into February, rising 12.6% during the period. The recent move was triggered by stockpiles held in warehouses operated by the LME dropping to their lowest level since 2005. A large jump in imports by China may explain the drawdown, which supports the positive impact that the country’s recent stimulus measures are having on global trade and global equity markets. Oil once again echoed this sentiment, rising 3.8% for the month despite record inventory reported.
Credit spreads in the US are replicating the optimism in equity markets. The ICE BofAML US Corporate BBB OAS dropped another 13bps to 1.71%, down from 2.05% at the start of the year. After a sustained contraction from over 3% in 2016 to sub 1.2% in early 2018, the measure is now riding along the bottom level of its 2018 range so the next move will be interesting to monitor. Highlighting the enthusiasm that 2019 has brought on has been the strength in WeWork’s 2025 bonds. WeWork seems to be somewhat of a fashion symbol for easy access to capital. To simplify the business model, WeWork will lease office space around the globe, fix it up to create a collaborative work environment, and then sublease on an as-needed basis to small businesses. The business required a heavy investment. IT reported net loss of $723 million for the first half of 2018 and rent commitments of $18 billion over the next decade. The Japanese multi-national conglomerate, SoftBank Group Corp. planned to acquire a majority stake in WeWork, but it needed to curtail its investment after it faced opposition from two main investors. The decision had a significant impact on WeWork bonds, as yields rose from 8.5% at its April issue date to 10.8% on 16-Jan-19. However, as credit markets rallied along with equity markets, the yield on these bonds have followed suit, dropping to 9.25% as of 25-Feb-19. For a business with large commitments and little security in revenue (tenants may terminate their agreement in one month), the availability and more importantly, cost of financing will certainly have a big impact on their ability to operate. We fear that the future of these bonds may correlate to many companies financed by cheap debt and questionable business models.