Bond Markets and the New Normal

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May, 2020

Bonds are currently creating a confusing picture for investors globally. Economies are in a bind due to COVID19, stories of vaccines are elevating peoples hopes for a quick return to the ‘old normal’, and the FED is throwing stimulus and rescue packages at it all, including corporate bonds. As a result, Equity Indexes are rallying and challenging previous highs, powering ahead despite these high levels and serious concerns over dividends. Then we have a trade war that was simmering before this started and is now showing signs of escalating and further throwing supply chains into disarray and damaging earnings of large global companies in a complex and difficult to predict manner.

We have huge national debts that are ballooning by the hour. Companies that have on the one hand been severely restricted in their activity have on the other had demand for their goods and services damaged. Consequently, most companies are in need of cash flow and in need of investments.

Government Bond yields have remained at low levels in the US as yields have been pushed down by the crisis and are being further held down by stimulus measures. Corporate spreads however have widened significantly, especially for high yielders, with concerns over business flow and revenues being hurt by COVID 19 and trade wars.

The cost of trading debt is about 3x the average pre-COVID19, but we are not at 2009 levels yet. This is due to two reasons; 1. Financial support from governments, and 2. It is early in the crisis still. It is very likely that companies will come under increasing stress and need to raise capital in a progressively more difficult environment. As company and economic reports are published it is highly probable that optimism will be dampened as realism sets in and Bond Spreads may yet push out much further if that happens.

For companies trying to raise debt now, there is a growing trend of companies reporting earnings before COVID19, which tries to imply conditions will return to the ‘old normal’ quickly and these are the numbers which investors should base their investment decisions on, not any numbers published during mid COVID19 crisis.
Some companies are reporting EBITDAC– earnings before interest, tax, depreciation, amortisation, and coronavirus– for the first quarter of 2020. This is an estimate to show profits were it not for the impact of COVID19.

ELFA has warned that anyone relying on such fictitious figures will help companies raise debt that they can probably not repay, and that the pricing attached would not be a true reflection of the risk taken.

The future certainly looks interesting, potentially rewarding and exciting, but very risky. There is therefore a subsequent need to understand debt and where the value is, both now and historically during other crises, to better understand the changes and decisions that are being made.

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