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Monday, 18 December 2017

The horizon, post-Verizon

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  • Anthony Peters

Anthony Peters sees a coming flood of secondary paper

“Never try to catch a falling knife”. That wonderful pearl of wisdom has been handed down from generation to generation of City folk but it is, truth be told, one of the most useless bits of advice any investor can find himself furnished with. Thus, I look at 10-year US treasuries and now comfortably wrapped around the 3% yield level and wonder whether they are a buy of a sell?

The answer, to some respect at least, may possibly be found in the persistent flattening of the 10s/30s curve which has seen the spread melt from 125bp in the spring of this year – it has spent most of the past two years above 100bps, peaking in November 2010 at 160bp – to an interim low last week at 89bp.

All the while, the front end of the curve has been merrily steepening as the monetary authorities assure players that rate action is not imminently on the cards. As little as we know how long a piece of string is, so we also have not a clue how far out non-imminent monetary tightening is.

The speed at which some areas of the economy are evidently recovering must be scaring the living daylights out of policy makers, irrespective of whether they see them as sustainable – good but scary – or in that they are no more than a short and highly explosive flash in the pan which is bad but equally scary. One way or the other, investors don’t seem to feel the need to play chicken with the Fed and have been exiting the long end of the investment spectrum.

The shift in the 10s/30s is as good a textbook example of a bear flattening as I can remember and if history is anything to go by, that very flattening will roll through the curve, a bit at a time. Yet, parking in T-bills is no solution either. In terms of total return that would be a fiasco for most investors.

Although the swap market is replete with asset/liability specialists, the actual bond market – after all these years I still struggle to treat guvvie markets and corporate bond markets as two entirely different entities – generally continues to lack people who truly understand their customers’ business. Actually, from time to time I even wonder whether the customers don’t themselves also lack people who understand their business. But that’s another story and which I will look at in greater depth at some time going forward.

It has been evident for some time that there is a disconnect between primary and secondary markets as investors’ ability to buy large chunks of new issues hugely exceeds the street’s ability to take them back in the same bite-sizes.

What brings me to look at the back end of the curve again? Well, the story which was going around about the Verizon funding which, as I write, is still in full swing. There had been some chatter about a 100 year tranche being considered. Investors might be heard animals who sometimes lack the ability to step back and objectively assess the environment – I only know of one major insurance company which could have but, at the persistent and totally unmovable insistence of its CIO, never bought a single piece of structured credit – but it would have seemed suicidal to lock away money for a century at 6% or thereabouts.

The 30yr/100yr yield curve, in as much as it exists, is as flat as a pancake and the duration pick-up between the two isn’t that great either – the 30 year bond has a modified duration of 17¾, the 100 year is at 24½. That long trade is for bull markets but has nothing to commend it in this point in the cycle. So, to me, the concept of a 100-year Verizon bond never sounded feasible.

Flood warning

In the event, the company is out there with its generously priced eight tranche offering and talk is now of it looking to issue somewhere between US$45bn and US$47bn across the maturities from 3 years to 30 years which blows away Apple’s previous record setting offering of US$17bn.

US$47bn is a chunky amount of money for the market to find at the best of times and that it is not at the moment. Investors will probably need to do a chunk of switching and it will interesting to see over the coming days how the street manages to deal with the flood of secondary paper which will no doubt be pouring out of all orifices.

It has been evident for some time that there is a disconnect between primary and secondary markets as investors’ ability to buy large chunks of new issues hugely exceeds the street’s ability to take them back in the same bite-sizes.

I might be barking up the wrong tree, but we might well see Verizon cause a repricing of secondary markets and I sense that serious players might within days find significantly better value in secondary paper than they will in the new Verizon deal, irrespective of how attractively it is being priced.

Meanwhile, as the 10s/30s have flattened and as I expect the flattening to continue to move down the curve, if I were to want to buy the Verizon, my money would go straight into the 7-year piece where I perceive the risk/reward to look most attractive. 

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