As Credit Losses Pile Up, One Bond Guru Dismisses Crisis Talk
(Bloomberg) -- He seems like the Pollyanna of credit.
While just about everyone on Wall Street is fretting about U.S. corporate debt, Hans Mikkelsen is remarkably carefree. Rather than worry about a collapse in investment-grade bonds -- which are down the most in a decade -- the Bank of America strategist says investors might want to take a deep breath.
To hear him tell it, there’s little reason for all the doom and gloom. Granted, the Federal Reserve’s interest-rate increases and a shift toward monetary tightening worldwide will lead to higher corporate borrowing costs. Yet despite a litany of dire warnings from some of the biggest names in finance -- like Scott Minerd, Leon Black and Marc Lasry -- Mikkelsen says companies are stronger than they’ve been in decades.
The last downturn left them better prepared to weather the economy’s ups-and-downs. U.S. growth remains steady, which will underpin earnings. And after years of gorging on ultra-cheap debt, companies are borrowing less as changes in taxes and regulations kick in. So forget all the worries that slower growth, escalating trade tensions and rising rates will invariably lead to a rash of junk downgrades, he says. Most investment-grade companies will do just fine.
“A lot of investors are pretty negative on fundamentals, I just have a more positive view,” said Mikkelsen, head of U.S. high-grade credit strategy. “You’re looking at a strong economy and companies issuing less debt. The credit risk associated with these names is actually relatively low.”
There are a couple caveats. Mikkelsen likes company bonds in the lowest reaches of investment grade, which many doomsayers say will be the cause of the looming crisis in corporate bonds. However, he only sees meager returns in 2019 from investment-grade debt as a whole. No crisis, for sure, but he’s still underweight relative to Treasuries. In fact, the bank is actually more bullish on riskier corporate debt like junk bonds and leveraged loans.
Mikkelsen, who has led Bank of America’s award-winning credit research team for well over a decade, isn’t one to shy away from bold predictions. In late 2012, in what has perhaps become his best-known call, Mikkelsen declared that a “Great Rotation” from bonds into stocks was about to begin. (It turned out to be pretty timely as investment-grade corporate debt posted a rare loss the following year, while U.S. stocks staged their biggest rally since 1997.)
More recently, he said investment-grade issuance this year would drop as much as 17 percent, which would be the biggest decline since 2010. To date, sales are down roughly 12 percent, data compiled by Bloomberg show, which is far more than most others on Wall Street predicted.
This time around, the implications go beyond who made the right call. How corporate America holds up during the next downturn could very well determine whether the recession, whenever it comes, turns into a full-blown crisis.
Since 2008, U.S. investment grade debt has more than doubled to roughly $5 trillion. About half is composed of bonds in the triple-B tier -- those with BBB+, BBB or BBB- ratings -- which have more than tripled. It’s here, in the lowest investment-grade category, where investors are most worried. (Anything rated BB+ or lower is considered junk.)
Many suspect companies are weaker than the ratings suggest, and could buckle under the weight of their debt once earnings slow.
Indeed, U.S. investment-grade bonds have lost 2.6 percent this year, on track for its worst year for returns since 2008. The extra yield investors demand to hold investment-grade corporate debt over Treasuries is the highest since July 2016. Meanwhile, Moody’s Investors Service sees credit market conditions deteriorating globally in 2019.
There are plenty of pessimists. Minerd, Guggenheim’s chief investment officer, said last month that leverage at companies in the triple-B tier is “unsustainable.” He also declared the “collapse in investment-grade credit has begun,” with the sell-off in General Electric Co. just the tip of the iceberg. Black, co-founder of Apollo Global Management, says credit markets have “gone into bubble status,” while Avenue Capital’s Lasry sees high-grade debt plunging as much as 40 percent in value when the cycle turns.
What’s more, Morgan Stanley’s economists have warned the jump in yields would ultimately hit jobs and growth and its strategists said over $1 trillion in bonds could be cut to junk when the economy turns.
That’s not enough to scare Mikkelsen. First, he says the U.S. economy, despite the hand-wringing over rates and weakening global growth, is unlikely to roll over any time soon. Second, new tax laws and tighter monetary policy have prompted companies to borrow less, which strengthens their finances.
If anything, the real selling opportunity is one tier up, with single-A rated bonds, Mikkelsen says. A lot of the debt comes from industries like tech, which is using repatriated cash to fund shareholder rewards rather than paying down debt, and industrials, which are being buffeted by weaker overseas demand and Donald Trump’s saber rattling over trade.
Regardless, Mikkelsen understands why investors are concerned about a corporate debt crisis and says many clients have called to specifically ask whether GE’s problems are some harbinger for a broader-market meltdown. This year, GE’s worsening cash flow situation has come to the fore in spectacular fashion, raising hard questions about how it will repay its more than $110 billion of debt. Those worries have been reflected in its BBB+ rated bonds, which have begun to trade like an average junk bond.
“A lot of questions I’ve been getting are what are the broader implications, especially of GE,” he said. However, GE is “a very idiosyncratic story. And increasingly, investors are going to realize this.”
©2018 Bloomberg L.P.