Page 1 of 2 Clippers kept happy By Julian Delasantellis
Many people might be surprised to learn that Karl Marx, far from being the
eternal, implacable enemy of the early industrial capitalists, actually looked
upon them quite favorably, seeing them as the avatar to the revolutionary
industrial change that would eventually culminate in communism. What he didn't
approve of was those who led lives of luxury on the backs of workers,
landlords, and especially those who made their living earning money on
interest, who he derisively dismissed as "coupon clippers", after the old
tradition of the corporate bondholder redeeming a coupon attached to the bond
to receive payment.
These days, the last thing you want to do is to ignore the corporate bond
market. In many ways, it has supplanted many of the more widely followed world
stockmarkets in terms of their
relative importance to the world economy; more importantly, it is in looking at
recent developments in the bond-, rather than in stock-, markets, can one see
just how all the king's horses and all the king's men, specifically former
Treasury Secretary Hank Paulson, his successor Timothy Geithner and Federal
Reserve chairman Ben Bernanke in the United States, along with United Kingdom
Chancellor of the Exchequer Alastair Darling, and Bank of England governor
Mervyn King, are trying to put the Humpty Dumpty world economy back together
again.
In August 1969, 400,000 US hippies celebrated the miracle of Woodstock; this
month, just about the identical number of people celebrated the miracle of the
US stock market, which has gained 30% just since the market's lows in March.
Other world markets have done just as well or much better; the Shanghai
Composite was up 68% to early in the month before a selloff, France's CAC-40 is
up over 40% from that time, Britain's FTSE 100 index is up 38%, the Nikkei 225
in Tokyo is up 48% Hong Kong's Hang Seng takes the brass ring of them all, up
over 80% since the world market bottoms in early March. Finally, it seems, the
world financial crisis's terrible chain-wielding ghost can be put back into
someone's dark nightmare once again, hopefully never to terrorize the world's
blessed equity market punters ever again.
But the entire equity market rally has been nothing but a non-alcoholic
dress-coded Jan and Dean college mixer compared with the orgiastic bacchanalia
going on in the world's corporate debt markets.
According to Ambrose Evans-Pritchard in London's Daily Telegraph, corporate
bonds are having their best rally in a century. In Britain, the green energy
company RWE, even after having its stock rally 35% off the March lows, is still
paying a 7.7% dividend yield on the stock; its five-year bonds, essentially
similar but for the fact that the bonds offer no real chance of capital
appreciation, are now paying 3.2%. At 50 basis points, the company's credit
default swaps, to be paid if the company defaults on its bonds, are essentially
being given away for free.
In the United States, before a recent pullback, the Barclays High Yield ETF
(exchange traded fund) was up almost 43% from March lows, and the bond/stock
divergence seen with RWE is also seen here. AT&T'S common stock dividend
earns 6.3%, while its five-year bonds pay only 4.6%.
This is not the way things are supposed to work, and, until recently, it wasn't
the way things were working. If, during the great bull market of 1982-2007, you
were looking for investments guaranteed to pay not much more than pocket
change, dividend paying American stocks were the way to go. Those were the
times when dividend paying fell out of favor in the curriculum at American
business schools, and so with the dark-suited, wing-tipped CEOs that rolled off
their android assembly lines
A stock market rally, by its very nature, is supposed to reduce dividend yield
(DY). DY is, at it's very simplest, a fraction that has the nominal dividend as
numerator and the current stock price as denominator, all things being equal,
the sharp rally in stock prices since March should have led to concomitant
falls in DY.
The anomaly between bonds' current low yield and stocks' current high yield
goes to the heart of their position in the structure of capital markets, and of
what changes these markets are going through as they commence the first,
faltering steps out of recession.
Both bonds and stocks exist in order to raise capital for companies; bonds are
IOUs wherein the company promises to return borrowed money along with a premium
determined by the bond's current interest rate. Stocks, or shares, are just
that, tiny pieces of the company that the company sells off in exchange for
capital the company can use to fund either current operations, or, preferably,
expansion.
Another similarity between bonds and stocks is that both can and are traded on
secondary exchanges once they are first sold by the company. Stocks, of course,
are traded on the familiar stock exchanges, but bonds have their own exchange
too, where their prices are determined. Nowadays newspapers are cutting the
space once devoted to the daily individual stock listings in favor of more news
about Twittering, but it wasn't that long that American big city metro
newspapers had full coverage of both bond and stock tables in their afternoon
editions - yes, there were even afternoon editions.
We all now that stocks move as a result of a number of factors, from the
chances of imminent war in the Middle East to the latest traffic ticket that
some trader's kid has earned that will cost the trader big on his auto
insurance policies. What they're supposed to move in accordance to, and what
most academic studies still say they do over the long term, is earnings - when
these go up shareholders have more money for themselves and vice-versa when
they go down.
Corporate bonds don't really care about earnings; whether earnings are high or
low the bondholder still gets back essentially the same thing - the principal
involved in buying the bond plus any accrued interest. (They also move in
reaction to changes in long-term interest rates, but not to the same extent as
do government bonds.)
What really moves corporate bond prices is the prospect that the bond won't get
paid back, since the bond's statutory pay-back date, whether two, five, 10 or
20 years in the future, is the only day when the bond has any real, intrinsic
value. The company has pledged its sacred honor to pay back the bonds, so
something dreadful, a declared or pending bankruptcy, must have occurred if the
company is unable to pay them back.
If savvy bond market investors see a company's financial prospects dimming so
much that its continued existence is in question, they'll sell bonds (or buy
credit default swaps on the bonds for protection) and that will drive the
bond's interest rates up. That's exactly what is not happening now.
Also, if there's so much confidence in the economic recovery, why aren't stocks
rallying sufficiently to put a real dent in dividend yield?
What message is these market phenomena really trying to send us?
I think what's really going on here is that bonds and stocks are finally
realigning to better match their trading particulars and profiles with the new,
post immediate crisis environment.
With all the bailouts and handouts from governments this past year to financial
system companies and just about everybody else, investors have finally come to
the conclusion that the question of who's too big to fail is being interpreted
very broadly these days. Hank Paulson stood on principle with Lehman Brothers
last September, let it go down the tubes, and was then surprised as it sucked
the entire capitalist world down the drain with it.
Paulson has gone now, but his protege Timothy Geithner is still around as US
Secretary of Treasury, and he and his colleagues in the Obama administration
seem to be totally committed to not
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