Credit Markets Flashing Caution Ahead?

Molly Smith of Bloomberg reports, General Electric Is Flashing Caution Signs in Credit Markets:
General Electric Co. may still have a relatively solid investment-grade rating, but investors aren’t taking their chances. They’re snapping up derivatives that protect against losses on the company’s debt.

The annual cost to insure against a default by GE for five years climbed above 200 basis points for the first time in years, credit-default swap prices from CMA show. That’s almost double what it cost just two weeks ago, and it’s the kind of level that hasn’t been seen for the company since the waning days of the global financial crisis.

That’s still well below the peak crisis levels for GE’s finance unit back then (GE Capital CDS surged to more than 1,000 basis points in March 2009). But the pace of the increase has been rapid, particularly when compared with the broader investment-grade market. Yields on some of GE’s bonds have also reached levels that are in line with junk-rated bonds, Bloomberg Barclays index data show.

Chief Executive Officer Larry Culp tried to reassure investors that the company is prioritizing debt reduction in its effort to combat a multiple-front crisis in a televised interview on Monday, when the bond market was closed. GE is facing weak demand for gas turbines, high debt levels and a federal accounting probe. Its shares have fallen more than 25 percent since Culp’s surprise appointment as CEO was announced Oct. 1, extending a sell-off that has wiped out more than $200 billion in market value since the end of 2016.

Representatives for Boston-based GE didn’t immediately provide comment.

‘Escalating’ Concerns

In his first earnings announcement as CEO, Culp said the company was cutting the quarterly dividend to just a penny a share from 12 cents in an effort to conserve cash and strengthen its balance sheet. Still, credit and equity analysts remain cautious. If GE’s credit ratings were further downgraded, the company could face rising borrowing costs and other expenses that would further pressure its liquidity, Gordon Haskett analyst John Inch wrote in a note.

GE may not be alone in facing these risks, some money managers fear. U.S. investment-grade bonds have been one of the worst-performing U.S. asset classes this year, as rising interest rates have lifted companies’ funding costs and sapped investors’ returns. More pain may be coming for investors, and it could be severe, distressed-debt money manager Marc Lasry warned late last month. Scott Minerd, global chief investment officer of Guggenheim Partners, said on Tuesday that more investment-grade credits will suffer.

“The selloff in GE is not an isolated event,” he wrote in a Twitter post. “More investment grade credits to follow. The slide and collapse in investment grade debt has begun.”

There are around $2.5 trillion of bonds rated in the lowest tier of the investment-grade universe, more than triple the level at the end of 2008. Some of those securities, including issues from GE and Ford Motor Co., trade like they are already rated junk.

Despite being cut to the lowest investment-grade tier, GE is still three notches above junk, with a Baa1 rating from Moody’s Investors Service, and an equivalent BBB+ from S&P Global Ratings and Fitch Ratings. All carry a stable outlook.

Yields on the company’s $1.95 billion of 3.37 percent bonds due in 2025 have climbed above 5.6 percent. That’s higher than the yield on a Bloomberg Barclays index of debt rated in the highest speculative-grade tier.

Meanwhile, GE’s only actively traded perpetual preferred stock now yields more than 15 percent, higher than some distressed credits. If the company chooses not to call the security in early 2021, it will convert into a floating-rate obligation that GE need never refinance.
After getting pummelled on Monday, General Electric (GE) shares were up almost 8% on Tuesday on huge volume after the company announced a plan to reduce its stake in Baker Hughes to shore up its liquidity by $4 billion (click on image):

GE bulls got excited today but it remains to be seen if this is another temporary reprieve where shorts covered and will be back on it as soon as possible (I wouldn't get excited about GE shares until they surge past $12.50 a share).

Anyway, the real risk in the company is reflected in how its bonds, not the shares, are trading. And from the looks of it, GE is far from being out of the woods:

What is more worrisome is if contagion from GE and the slide in oil prices will hit investment grade bonds. In a tweet, Scott Minerd, Guggenheim Partners chairman of investments and global chief investment officer said: "the slide and collapse in investment grade credit has begun."

James Crombie of Bloomberg states the following:
Rising rates have hammered investment-grade debt amid growing concerns about credit quality in the BBB rated tier. The recent equity and oil slumps, Cboe Volatility Index spike and rising concerns about trade wars, Brexit and Italy also pressured junk bonds, which are still positive for the year, despite a big loss in October.
In case you didn't notice, crude oil futures were down nearly 8% on Tuesday in very heavy trading (click on image):

The slide in oil prices is almost unprecedented. According to Bespoke Investments, this is the fastest crude oil has gone from a 52-week high to a 52-week low (30 trading days) since at least 1984:

Not surprisingly, energy shares (XLE) are down again and are close to making a new 52-week low (clcik on image):

I've been short energy but from a trading perspective, when you see moves like this, you have to wonder whether it's way overdone in the short run.

Earlier this afternoon, I emailed an astute commodity trader and asked him what is going on with crude oil prices, down so much so fast. He replied:
Capitulation! The last bulls were counting on OPEC to announce that they would cut production after crude had already fallen by 16$ (76$ to 60$). The fall was due to the waivers granted to 8 countries by the US in their purchases of Iranian crude and just when everyone was expecting anything from the producers... President Trump tweeted that Saudi Arabia and OPEC shouldn't cut at all..they have their hands tied.

And the positioning was still very long among specs in WTI.. and CTAs smelled blood and added to their shorts.

Kind of self-fulfilling downward spiral that we could see in the S&P one day...
On a brighter note, he added this on nat gas futures which have been doing well:
Nat gas is up 7.5% today and 25% since the beginning of the month. Inventories are around 18-20% lower than the 5-year average and colder weather is forecasted for the beginning of December.
A great trade would have been to short oil and go long nat gas over the last month but who would have known the divergence would be so wide (Note: The Macro Tourist put up an interesting post of a large energy hedge fund taken to the chipper on the crude oil - nat gas spread).

Interestingly, Not Jim Cramer tweeted this showing the correlation between S&P earnings and crude oil prices:

It all remains to be seen how the slide in oil impacts earnings but I think it's safe to assume major downward revisions are headed our way.

It also remains to be seen how the slide in oil impacts the high yield market which remains the canary in the coal mine.

If you look at the one year chart, there is some concern, but over the last five years, high-yield bonds (HYG) are still in an uptrend (click on charts):

So take Scott Minerd's dire warning with a pint of salt, there's still no reason to worry about a blowup in the high yield market.

Below, Bruce Richards, chairman and chief executive officer at Marathon Asset Management, discusses policy and market fallout from the midterm elections, the high yield bond market, and the factors that will lead to the next US recession in 2020. He speaks with Bloomberg's Vonnie Quinn on "Bloomberg Markets" (click here if it doesn't load below).