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The Pundits Are Wrong: The Bull Market Is Not Over Yet


This bull market is not going to end until the corporate bond market stops handing companies tons of free cash, which they in turn use to buy back their stocks.

Almost two years ago I wrote the first of a series of articles based on the lessons Rosenblatt's Brian Reynolds taught me about the relationship between corporate bonds and stocks. As Twitter (NYSE:TWTR) streams are replete with suggestions that the bull market that began five years ago is inevitably over, and because such suggestions from market pundits are even more common now that we've seen some losses in the Dow (INDEXDJX:.DJI) and S&P 500 (INDEXSP:.INX) stock market indices, I will reiterate my view -- based on Brian's thesis -- that this bull market will not be over until the corporate bond market stops handing companies tons of free cash, which they in turn use to buy back their stocks. I noted in this post on the Buzz & Banter (subscription required), and I am reprinting the charts here, that money flows in and out of stocks from all market participants have basically been a wash since 2007, except for two participants: Households and Hedge Funds (H/HF) on one hand, and companies buying back their stock on the other; during 2007-2009, when the bond market pulled the plug on financing buybacks, stocks were abandoned to H/HF selling. Since '09, when the corporate bond market re-opened for companies, the buybacks have overwhelmed H/HF selling.

Click to enlarge

Click to enlarge

So to put the recent stocks pullback in perspective, I think it useful to look back at the corrections of the last three years and see how bonds and stocks behaved in those occasions. The reference prices I will use are the Nasdaq Index (INDEXNASDAQ:.IXIC), the Barclays US Corporate High Yield Index (LF98YW) and my index of large US Financials CDS. In addition, I am listing the amount of new corporate bonds issued during those shakeouts.

March 30, 2012 to June 1, 2012 (62 Days)
CCMP:                  From 3091 to 2747 (-11.1%)
LF98YW:               From 6.74% to 8.03% (+128 bps)
FINSCDS:             From 798 to 1121 (+323 bps)
Bond Issuance: $199B ($3.2B/day)

September 14, 2012 to November 16, 2012 (63 Days)
CCMP:                  From 3183 to 2853 (-10.3%)
LF98YW:               From 6.06% to 7.75% (+170 bps)
FINSCDS:             From 578 to 626 (+323 bps)
Bond Issuance: $365B ($5.8B/day)

May 10, 2013 to June 21, 2013 (41 Days)
CCMP:                  From 3498 to 3357 (-4%)
LF98YW:               From 5.03% to 6.83% (+180 bps)
FINSCDS:             From 371 to 516 (+145 bps)
Bond Issuance: $172B ($4.2B/day)

March 7, 2014 to April 11, 2014 (35 Days)
CCMP:                  From 4336 to 4000 (-7.7%)
LF98YW:               From 5.26% to 5.00% (Minus 128 bps)
FINSCDS:             From 279 to 276 (Minus 3 bps)
Bond Issuance: $168B ($4.8B/day)

I have saved for last the figures from the summer 2011 drop just to highlight how much worse things have gotten before, only to roar back:

 July 22, 2011 to November 25, 2011 (125 Days)
CCMP:                  From 2858 to 2341 (-18%)
LF98YW:               From 7.11% to 9.76% (+265 bps)
FINSCDS:             From 576 to 1524 (+948 bps)
Bond Issuance: $339B ($2.7B/day)

So in the scheme of things, the current correction is by far the one during which credit and equities are diverging the most -- for the better.

When I tweeted the gist of the above over the weekend, I received a recurring kind of pushback -- namely, how can I tell that this time the corporate bond market is not shutting for good. I can offer three answers to that.

First, by the way the corporate bond market is behaving, it simply isn't; spreads on bonds and CDS are tighter, issuance is large (especially for what is usually a seasonally slow period), and looking at FINRA's Investment Grade and High Yield volume of actively traded issues, the 10-week average volume just made five-year highs for both sectors. 

Second, the allocations of funds to credit by pensions and other large credit buyers not only continue, but they continue to increase. You can, in part, track that in Pensions & Investments Magazine

And lastly, if you think that the first two reasons above do not matter this time around, I will repeat what Canaccord's Tony Dwyer told me circa 2005, when I was arguing that the housing bubble was just one more day away from popping, even though it would be another two-plus years before the corporate bond market would correctly signal such implosion: "It is entirely possible that the sun will explode tomorrow, but that does not make it a very good bet."

Twitter: @FZucchi

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