Narratives

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Several recent research reports have discussed an upcoming wave of $4 trillion of bonds that need refinancing over the next five years.  $4 trillion sounds like an astronomically high number since this is only referencing corporate debt.  This amount also represents roughly two-thirds of all outstanding corporate debt.  While most of this is investment grade, there is also a fair amount of non-investment grade and levered loans that need to be refinanced.  This chart showing the wave of maturity was published in Bloomberg and subsequently picked up in multiple fixed income articles.  Looking at this ominous chart makes it seem as if this upcoming maturity wave, coupled with rising rates, is inevitably going to doom the financial markets. But is it really inevitable?

In this economic world, there are many ways to view and interpret information.  Shortsighted presentation and limited facts, all spun with a compelling narrative can make even the most sophisticated readers believe the story!  I would like to add enlightenment to the conversation, by looking beyond the narrative that is being presented to a fact truly matters: the cost of the debt.

 As pictured below, the past 10 years have delivered large movements in the 10-year treasury yield, ranging from over 4% to under 1.4%.  As rates have now risen to the middle of this range, the rising rate narrative seems to have taken hold of the news networks. It begs the question, will these rising rates cause corporations to pay significantly higher borrowing costs on their debt? Is the narrative true?

Source: Perhsing Market Q

Source: Perhsing Market Q

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The Bloomberg article misses an underlying fact: the cost of the debt maturing, the fact that matters. Take a look at two sections of the bond market that were referenced in the Bloomberg article, Investment Grade and High Yield.  The two charts on the right reflect both the Yield to Maturity (red lines), and the Time to Maturity (blue lines) of the Investment Grade and High Yield bond markets. 

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Let’s address the facts about the cost of debt.  The average maturity of investment-grade typically fluctuates around 7-10 years, while the yield on the bonds has hovered around 5%. Corporations that issued above this rate, will benefit by the upcoming refinance, as they will refinance at a lower rate.  Of course the opposite is also true, corporations that issued below that rate will be marginally worse off when refinancing.  However, overall it appears that this is a break-even cost of debt event for the corporate bond markets. It is unlikely that a break-even cost event can cause financial calamity as the Bloomberg article suggests.  The same scenario plays out in the High Yield bond market, just with a different set of rates and maturities.  By looking at the fact that matters, the cost of debt, this maturity wave narrative loses its frightening power, as it is evident that corporations will be operating in a similar rate environment as they did in the past.  I would also add, quality corporate managers will be able to maneuver their capital structures around the maturity wave by refinancing early or using different pools of capital.  This further mitigates any potential damage.

We firmly believe that interest rates are based on growth and inflation.  Neither growth nor inflation have increased drastically, with GDP growth hovering at 2.5% and inflation remaining close to 2%.  As the rising rate narrative continues to move markets, we must remember that this level of rates occurred as recently as 2014.  The market has survived and thrived with the same rates in the past, and I believe the market will continue to survive and thrive through many more rate environments.  As managers we must be vigilant and not allow a one sided narrative take the place of facts. 

 

Disclosures

Registered Representative offering securities through Cetera Advisor Networks LLC, member FINRA/SIPC. Advisory services offered through Carroll Financial Associates, Inc., a Registered Investment Advisor. Carroll Financial and Cetera Advisors Network, LLC are not affiliated. Orders to buy or sell securities cannot be accepted via e-mail or voicemail. E-mail correspondence is routinely monitored for regulatory compliance purposes. Everything we’ve discussed is just our opinions, they should not be construed as a suggestion to buy or sell any specific investment.  All Information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance information is historical and not indicative of future results.  You cannot invest directly in an index.  Past performance does not guarantee future results.