If The Smart Money Is Selling, Should We Be Buying?

Stocks-and-BondsAn interesting question was raised in a Wall Street Journal article this week. The article was titled “New-issue Flurry Hints at Trouble,” and the question was this:

“When new issues become as massive as they are today, can it mean that markets are overheating and getting ready to give back some gains?

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E. S. Browning writes in the Wall Street Journal article “Companies are racing to issue stock and bonds because markets are high, offering great prices for sellers.”

The game: “issuers are grabbing current terms before markets fade. That makes experienced investors ask themselves a classic question: If the smart money is selling, should we be buying?”

Dealogic, a data service and advisor to investment banks, indicates that $911 billion in corporate bonds of United States companies have been issued so far this year. This is the largest amount that appears in the database of deal logic.

Furthermore, the volume of developing-country corporate bond issues has gone above $802 billion, slightly less than the $812 billion issued in the same period last year which was the largest amount on record.

This is important to consider because interest rates on bonds have been rising for a good portion of this year. I have written about this in previous posts. I have talked about the yield on the 10-year US Treasury issue moving from around 1.60 percent to 3.00 percent before modestly falling back off.

The primary reason I gave for this is that a lot of funds from Europe that had been parked in sale-haven US Treasury securities because of the financial turmoil occurring on the continent, returned to Europe this spring and summer as financial markets became a lot calmer.

In addition to this, the Federal Reserve, which has been buying $85 billion in US Treasury securities and mortgage-backed securities for a lengthy time, hinted in May that it might begin to lessen the size of its monthly purchases. The thought was that this “tapering” would begin in September. The idea that this might happen also contributed to the decline in bond prices and the rise in bond yields.

The bond market has been dwelling on what the Federal Reserve is going to do ever since. As it appeared that the economic data were still too weak, bond prices rose and interest rates backed off. The interpretation was that with the economy still so weak that the Federal Reserve would not begin to “taper” in September. Market consensus put the time back to March when the Fed would begin to “taper”.

This, however, was interpreted by investors as an “easing” of monetary policy because of the earlier expectation. The market expected them to purchase fewer securities beginning in September, but now their purchases would not drop until at least next March and this meant that the Fed was expected to purchase a greater amount of securities than this earlier expectation.

But, market participants believe that the Federal Reserve will have to begin to lessen the amount of securities it purchases every month at sometime in the future. These investors also know that the Federal Reserve, at some time in the future, is going to have to actually start removing reserves from the banking system…that is, it will have to start selling securities.

Both of these possibilities mean that at some point in the future, longer-term interest rates are going to have to rise.

So, longer-term interest rates are going to have to rise. The question is, has the market reached a bottom for longer-term interest rates.

A lot of analysts would argue that this is why there are so many bond issues being brought to market. Many corporations in the United States and in developing countries seem to believe that if we are not at a bottom in longer-term interest rate now, the bottom will be reached in the near future.

The betting is that longer-term interest rates are not going to be this low…for a long time!

Therefore, those that can need to go to the financial markets and raise what they can.

When did this start? Well, one can say that it really got going with the Verizon offering on September 10. Verizon raised a record-setting $49 billion. Wow!

On September 10, the yield on the US Treasury bond closed just below 3.00 percent. The portion of the Verizon deal that had a 10-year maturity sold to yield 5.20 percent. The portion that had a 30-year maturity sold to yield 6.55 percent.

This opened the door. And, corporations, following Verizon’s lead have crowded the agenda ever since. Interest rates are expected to rise. Get your money while the getting is good.

This signals, to some market watchers, that the low rates…and the high stock market prices…are near their turning points. If the issuers of bonds believe this to be a very good time to issue bonds, then one can interpret this as meaning that the fall in bond prices…and the rise in bond yields is somewhere in the near future.

Adding to this, the author notes that so far this year US companies have also issued $51 billion in first-time stock issues or initial public offerings. This is the most that have come to market in this time period since 2000 when there were $63 billion coming to market in IPOs. That author notes that this was the year that the bubbles in tech stocks and IPOs both popped.

So, some market watchers are saying…stay loose!

About John Mason

John MasonJohn has been the President and CEO of two publicly traded financial institutions and an Executive Vice President and CFO of a third. He has also spent time as an economist in the Federal Reserve System and worked for a cabinet secretary in Washington, D. C. In addition John taught in the Finance Department at the Wharton School of the University of Pennsylvania for ten years. He now currently has a column on the blog Seeking Alpha and is ranked number 3 in terms of readers on the economy. From this column, two books have been published this past year from earlier blog posts. John is active in the shadow banking world, the venture capital space, and in angel investing. Other than that John works with start ups and early stage organizations, for profit and not-for-profit.

 

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