Libor's Gains Won't Hinder the Bull Market. They May Even Help.

(Bloomberg) -- Trade tensions. Margin pressure from rising freight and labor costs. A deceleration in global economic activity.

There are plenty of concerns, both at home and abroad, that’ll be causing Corporate America angst as earnings season heats up. But the surge in short-term interest rates isn’t one of them, says Canaccord Genuity strategist Brian Reynolds.

Reynolds says “only a random handful” of S&P 500 companies will be adversely affected by 2018’s more than 60 basis point rise in Libor, a gauge of banks’ borrowing costs to which trillions in loans are pegged. That’s because they’re much less exposed to such borrowing than they used to be, having used a low-interest-rate environment to extend average maturities through bond issuance more than floating credit facilities.

Before the dot-com and housing bubbles burst, short-term debt accounted for roughly half of public credit outstanding, according to Reynolds.

"Now, this number is down to 14 percent, making the issue of Libor almost a nonevent for large-cap companies that have not only termed out their debt but also balanced their assets and liabilities from an interest rate perspective," he said.

In fact, Reynolds even thinks investors with a longer-term horizon should welcome this development because of its potential to help extend a credit-driven bull market in risk assets.

"Libor’s rise will be an eventual financial-market positive because the recipients of these increased interest payments will be our nation’s pensions, insurance companies, and banks who own floating rate debt," he writes. "They are likely going to channel the proceeds back into leveraged credit, resulting in five times the equity buybacks."

Goldman Sachs Group Inc. argued earlier this month that S&P 500 constituents with a high share of floating-rate obligations had "mirrored" the rise in short-term rates by underperforming the broad U.S. equity benchmark in the first quarter. However, their list included companies like Apple Inc. (which generates positive net interest income relative to expenses) and Qualcomm Inc., which lagged the S&P 500 substantially after Broadcom Ltd.’s takeover of the chipmaker was blocked by the White House.

Smaller companies -- which lack the same access to capital markets that their larger peers enjoy -- as well as households with floating-rate mortgages will feel the pinch of Libor’s increase, Reynolds acknowledged.

But even amid the relentless rise in Libor year-to-date, the S&P Small Cap 600 and Russell 2000 Indexes have posted better returns than the S&P 500 Index. That indicates fears about what rising short-term rates will do to financial results have not been the dominant driver of relative performance in 2018.

To contact the reporter on this story: Luke Kawa in New York at lkawa@bloomberg.net.

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Joanna Ossinger, Andrew Dunn

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