So in this week's conversation we will look at these "glitters" we are seeing which definitely ain't gold and warrant caution as we move into 2014 which could mark the final innings of the long rally initiated in 2009 courtesy of central banks generosity.
In light blue: S&P 500 buybacks
In purple: NYSE Margin debt
In green: inverse US labor participation rate.
Multiple expansion through share buybacks have been driving indeed the stock market higher greater than earnings have. The S&P 500 has risen 26.7% YTD versus 16% for the trailing PE from 16.4x to 19.1x. Buybacks rose by 18% QoQ to $118 billion in 2013, up 11% YoY to $218 billion in 1H13. The S&P 500 trades at 25x cyclically adjusted PE ratio (CAPE), exceeding the highs reached in 1901 and 1966. In 129 CAPE reached 33x and in 2000 44x. The growing divergence between the S&P 500 and trailing PE since January 2012 - graph source Bloomberg:
And it cannot be truer if either one looks into the rise of the S&P500 between High and Low Quality Stocks - graph source Bloomberg:
Or if one looks into the outperformance of the Small-Cap ratio versus the underperformance of the S&P 500 Utilities index - graph source Bloomberg:
Another sign of the real "Great Rotation" has been the continuous selling from Institutional clients while private clients have been stepping in as reported by Bank of America Merrill Lynch in their recent equity client flow trends report from the 26th of November entitled - "Little confidence in equities' new high":
"Institutional clients lead selling; retail clients return to buying
Last week, during which the S&P 500 climbed 0.4% to reach another new all-time high above 1800, BofAML clients were net sellers of US stocks for the fifth consecutive week, in the amount of $2.3bn. Net sales were led by institutional clients, who returned to net selling following a week of muted buying. Institutional clients remain the biggest net sellers year-to-date (Chart 1), with cumulative net sales of over $23bn—larger than in either 2008 or 2010.
Hedge funds were also net sellers for the second consecutive week, while private clients returned to net buying after a week of selling. This group has been a net buyer for 23 of the past 26 weeks. Large, mid and small caps all saw net selling last week." - source Bank of America Merrill Lynch
Another illustration of this "Great Rotation" comes from the same Bank of America Merrill Lynch report which displays BofAML institutional client cumulative net buys of US equities: pension funds and institutional ex. pension funds since 2008:
Of course, the credit markets have been also indicative of not only investors dipping their toes outside of their comfort zone but most of all the on-going "japonification" such as in the loan market as indicated by Christine Idzelis in her Bloomberg article from the 21st of November entitled "Loan Faults Seen in $250 Billion of Refinancings":
"The demand has helped companies issue $581 billion of loans to non-bank lenders such as hedge funds and collateralized loan obligations, up from $366.4 billion in all of 2012, Bloomberg data show. At the current rate, the record of $581.5 billion in 2007 may be broken as soon as today.
“I don’t think there’s much of a resemblance between now and 2007 other than it’s a borrower’s market,” A.J. Murphy, global co-head of leveraged finance at Bank of America Corp., the largest underwriter of leveraged-loans in the U.S., said in a telephone interview. Leveraged buyouts are smaller than they were six years ago, she said.
The top five LBOs this year averaged about $12 billion, compared with $30 billion in 2007, Bloomberg data show." - source Bloomberg.
We must say we have been quite amused by the above quote, we all know "this time it's different. One thing for sure, 2013 has been the biggest year since 2007 for CLOs as indicated by Kristen Haunss from Bloomberg in her article from the 26th of November entitled "Wall Street Props CLO Boom as Rules Lift Costs":
"The biggest year for collateralized loan obligations since 2007 is being propped by deals managed by Blackstone Group LP and Carlyle Group LP, which started funds that pledge to boost interest rates on the debt.
While $87 billion of CLOs have been issued globally this year based on JPMorgan Chase & Co. data, coupons on the highest-rated portions have risen to as much as 1.5 percentage points over the benchmark from at least a three-year low of 1.1 percentage points in May. Yields rose as GSO Capital Partners LP, the credit arm of Blackstone, Carlyle and other money managers sold at least $4.5 billion of CLOs with the promise of higher interest payments, typically after 18 months.
Money managers and banks are finding new ways to ensure investors keep buying CLOs -- which bundle junk-rated loans used to back buyouts -- after the Federal Deposit Insurance Corp. asked lenders in April to designate AAA rated portions of the notes as “higher-risk” assets. Regulators are now considering more rules targeting the funds, which helped push issuance of leveraged loans this year to a record $277.1 billion, according to data compiled by Bloomberg.
“AAAs continue to be the hardest to sell and banks have become creative in order to distribute the debt,” Ken Kroszner, a Stamford, Connecticut-based CLO analyst at Royal Bank of Scotland Group Plc, said in a telephone interview. At least 10 CLOs sold since June offered a so-called step-up coupon, where rates increase over the life of the deal, according to Kroszner." - source Bloomberg
If you think 2013 was a record year, wait for 2014. 2014 for us points towards the last inning of the game being played thanks to "easy money". Why so? You might rightly ask.
2014 will see the return of big LBOs so as a credit investor, you should switch on your LBO screeners we think. Anne-Sylvaine Chassany from the Financial Times in her article entitled "Private equity's dry powder' raises overcapacity concerns":
"Private equity groups are holding more cash for acquisitions than they had at the height of the leveraged buyout boom, in spite of a fall in the volume of deals being done – raising concerns about overcapacity in the industry. Data compiled by Preqin, the research group, show that the value of unspent commitments to private equity funds, known as dry powder, has surged to $789bn this year – an increase of 12 per cent since December 2012, after four years of decline. This compares with $769bn of unspent cash in 2007 – when the volume of private equity deals reached a peak – and the $829bn that went unspent in 2008, when deal volumes plunged 70 per cent as the financial crisis unfolded.
In 2007, private-equity houses led $776bn of deals, but the comparable figure stands at just $310bn in 2013, according to Thomson Reuters. Research by Hamilton Lane, a private equity investor that tracks 2,000 funds, says this combination of increased fundraising and decreased deals could lead to a record level of dry powder by the year end.
Buyout groups’ rising cash piles reflect the fact that they have taken longer to invest their funds since the crisis, as they have found fewer good opportunities. But the increase in the capital overhang has been largely fuelled by a renewed appetite for private funds from yield-starved investors.
After a steep contraction in the aftermath of the crash, buyout groups have been able to raise more money from investors, partly because they have found ways to return cash from previous vehicles – mostly through refinancings and initial public offerings. This has helped Advent International, Warburg Pincus, CVC Capital Partners, Carlyle and Silver Lake raise more than $10bn each for new funds.
According to Mario Giannini, Hamilton Lane’s chief executive, 2013 is on course to become “the fourth biggest fundraising year” of all time for the private equity industry, as investors are lured by its higher returns.
Private equity funds have attracted $279bn this year, more than the whole of last year, Preqin has found. Some industry participants warn that the cash overhang will drive asset prices up as groups feel the pressure to invest the money before the commitments expire, typically after five years." - source Financial Times - Anne-Sylvaine Chassany
The latest manifestation of the consequences of "cheap credit" and record cash is leading outside players such as private equity investors to dip into the structured finance shipping business as reported by Mark Odell and Aja Makan in the Financial Times on the 27th of October in their article "Wave of private equity money flows into shipping":
"Private equity has been drawn to the sector as asset valuations for both new-build and second-hand ships have hit rock-bottom.
As a highly-fragmented industry with few large players, the need for capital could hardly have been greater. Traditional lenders such as Germany’s Commerzbank and HSH Nordbank and the UK’s Lloyds and Royal Bank of Scotland are either exiting the market or looking to reduce exposure, stung by heavy losses on loans made before the downturn.
Ship owners looking for fresh funds have found private equity groups willing to listen as they struggle to allocate capital in their more traditional markets.
Oaktree Capital Management, for example, last year took a large stake in Floatel, which owns and operates offshore construction support vessels, and injected equity into General Maritime, a crude and petroleum product tanker company.
Other groups are investing directly in ships. This summer Carlyle committed more than $100m to InterLink Maritime, allowing it to order ten bulk carrier ships, while in September Apollo Global Management committed to a joint venture with German freight line Rickmers Group to invest up to $500m initially in second hand ships.
Before that York Capital linked up with New York-listed Costamare, a container ship owner, in another $500m joint venture. “The reason they are here is high expectations about returns as they are entering at the low-part of the cycle,” says Greg Zikos, chief financial officer of Costamare.
These expectations have so far this year attracted more than $2.7bn, a quarter of the total investment in ships led by private equity since 2008, according to data compiled by Marine Money, a US-based consultancy.
Bankers and analysts say the money has targeted specific “hot” sectors of the market, especially product tankers, which carry refined products, and vessels to carry liquefied petroleum gas and liquefied natural gas. There has also been a renewal of orders for dry bulk carriers.
On top of the $11.2bn invested in ships and indirectly in shipowners since the start of 2008, private equity groups have also been investing in terminals, ship charterers and shipping containers. In August, KKR led $580m in funding for a specialist shipping bank." - source Financial Times, 27th of October - "Wave of private equity money flows into shipping"
"But the presence of the “new” money has been noted. At a shipping industry conference in New York this summer a Greek shipowner, whose family had been in the industry for generations, took one look at the audience dotted with private equity executives, before asking the organiser: “Where are all the shipowners?”
His question was only part in jest, says Jim Lawrence, chairman of Marine Money, who organised the conference. Private equity executives not only look different – the Greek shipowner was shocked by the number of dark suits facing him – they act differently.
Whereas traditional shipowners tend to hold vessels for at least 20 years, private equity groups hope to turn a quick profit by listing companies or selling their vessels once charter rates and ship valuations recover." - source Financial Times, 27th of October - "Wave of private equity money flows into shipping"
The issue of course for our private equity friends that they will soon discover is that if quick profits depend on valuations, they also depend on "recovery". We think they are bound for some disappointment as overcapacity is still plaguing the industry.
Shipping has been our favorite deflationary indicator, so we give you the latest reading of the Drewry-Hong-Los Angeles container rate benchmark. The container rate has been increased by $400 USD on the 15th of November on all US destinations with no impact so far for the "recovery" desired by Private Equity - graph source Bloomberg: