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The InterPrime Newsletter - Issue #12 - The corporate bond markets & a market update

The InterPrime Newsletter
The InterPrime Newsletter - Issue #12 - The corporate bond markets & a market update
By The InterPrime Team • Issue #12 • View online
“With a good perspective on history, we can have a better understanding of the past and present, and thus a clear vision of the future.” — Carlos Slim Helu
We wanted to highlight two interviews from the last month:
Founders on Finance Episode 4: Jacob Sheldon of SiliconCFO
We talk about the creation of the only fractional CFO marketplace, how Jacob went from builder to founder, and crowdfunding advice for founders. Check out SiliconCFO!
Our Co-founder & CEO Kanishka Maheshwari was on the Startup Foundations Podcast hosted by our friends over at Capbase.
Hear him talk about, his founder journey, what it’s like to be a foreign founder, what to look for in a co-founder and all things InterPrime!
In this edition of the newsletter, in addition to providing a market update, we will be sharing an in-depth look into how the corporate bond markets have been functioning over the last 18 months.
These markets are arguably amongst the most important as they determine the “cost of capital” for the vast majority of corporations.

When money is cheap, corporations borrow!
There is always chatter about how money is cheap and big companies can borrow huge amounts at low interest rates. This issue will provide insight into how much “cheap money” is really there, who is able to take advantage of it, and how they benefit and put it to use.
When people refer to “cheap money” they are almost always referring to money that’s borrowed as a loan of some type - either from a bank or other financial institution, or directly from market participants in the case of bond issuances. 
At a high level the mechanics of these “loans” can be straightforward. There is a principal (amount borrowed), an interest rate (that is paid), and a term (which can be fixed or variable).
The borrower gets the money and is able to use it for their corporate purposes and (hopefully) is able to generate a return greater than the interest rate they pay. 
The lender collects interest payments, with return of principal at the end of the loan term.
If you are interested in learning about how the corporate bond market functions you can read our corporate bond primer here.
We are now going to give you a glimpse into what’s been happening in the corporate bond markets in the last 18 months post being hit with COVID-19. Hint: The market is as strong as it’s ever been with yields at generational lows and bond issuances at all time highs!
Recent Corporate Bond Issuances
Yearly corporate bond issuances since 1996 Source: sifma.org
Yearly corporate bond issuances since 1996 Source: sifma.org
As we can see corporate bond issuance has EXPLODED post COVID-19. Over $2 Trillion of bonds were issued in 2020 itself, and in 2021 we are on track to exceed that with over $1.2 Trillion already issued thus far.
This was made possible by the actions of the U.S Federal Reserve in response to the COVID-19 pandemic. They took the unprecedented step of basically under-writing the entire corporate bond market, by reducing interest rates to near 0, and starting to buy these bonds on the open market! If you wanted to sell, you always had a willing buyer, the U.S. Federal Reserve, and as we know their supply of funds seems to be unlimited!
Companies that could previously not get a loan anywhere, I’m looking at you Carnival Cruises, are able to raise Billions of dollars at comparatively low rates in the junk bond markets ($2.4Billion for 7 years at 4% in July 2021 source: bloomberg). Oh, and the best part about these bonds is that they are unsecured! In the past, a lot of the debt that Carnival took on was secured by their cruise liners. 
In the investment grade bond market, strong companies like Apple, Oracle & Salesforce are able to raise 10s of Billions with maturities extending out 40 years for just a few percent! Yes, you read that right, 40 years!
Here are the details of Salesforce’s recent $8B bond issue 
 
  • $1.0 billion of its senior notes due 2024  (3yr) at 0.625%
  • $1.0 billion of its senior notes due 2028  (7yr) at 1.5%
  • $1.5 billion of its senior notes due 2031  (10yr) at 1.95%
  • $1.25 billion of its senior notes due 2041  (20yr) at 2.7%
  • $2.0 billion of its senior notes due 2051  (30yr) at 2.9%
  • $1.25 billion of its senior notes due 2061 (40yr) at 3.05%
 
 
Now that’s cheap money! You must be thinking what are they doing with all this money? 
 
Well, Carnival and other companies are using it to fund their day to day operation, as they are presently cash burning enterprises (due to the impact of the pandemic). 
 
Salesforce on the other hand is using this money to fund the acquisition of Slack (they are using this for the “cash” portion of the deal). 
 
Oracle and other similar companies are using this cheap money to buy back shares, as a way to return capital to shareholders. 
 
All this sounds fine in theory, but the key idea that the bond holders of these companies are counting on is that whatever the companies do with the money, they are able to generate a sufficient return to PAY THE MONEY BACK with INTEREST. Because if that does not happen…
 
So now that we know that corporate bond issuance is at an all time high, what do we think will happen in the future? With the caveat that the future is hard to predict, we will make a guess that some of the weaker companies will have trouble paying back the money they have borrowed and will likely have to restructure their businesses in order to make bond holders whole. 
 
Additionally, the other risk long term corporate bond holders take on is interest rate risk. So if we see any kind of inflation in the next few years, the folks that bought these bonds at rock bottom rates are going to see their returns suffer hugely. The increase in interest rates that inflation would bring, will reduce the value of these “lower interest” bonds, impacting real returns on capital. 
 
The companies that issued the bonds on the other hand will be rewarded handsomely as they locked in that “cheap money”. They will be the ultimate winners no matter what rates do!
 
The moral of the story being that it’s always best to borrow money when you don’t need it, and when the economy is flush with cash looking for a place, any place to go!
July 2021 Markets Update
As seasons change, so do financial markets. 
Summer excitement starts with a blaze of glory. Usually with stock markets rallying higher. Then a lull as vacations and time away from desks grow. The finale is more volatile as people funnel back to work and school begins for fall. 
So far, this seasonal tendency has proved itself again in 2021. That means, be ready - the bullish window may come to an end in the coming weeks.
The COVID situation lingers, and news streams give us daily squawks about the Delta variant. One thing seems consistent. The unfortunate hospitalizations are focused on the unvaccinated.
 
We mention seasonality and COVID because they will drive August market action. Both have the ability to make the rest of summer trading exciting, if not dangerous.
Bonds & Rates
In the previous market update we highlighted the change in the Federal Reserve dot plot. And how that could push front end interest rates higher. This did happen, but only temporarily. All things considered - things are still far away from a “normal” yield market.
Our expectation was the US 2-year note would move up to 0.23% - 0.28%. It topped out at 0.27%. Do we get credit for being closest to the pin?
Looking forward we assume a new balance area will build between 0.19 - 0.27%.
All this depends on inflation data. The June and July inflation prints have been some of the largest rises in 10 years. If this pattern continues, the Federal Reserve could adjust front end rates before the end of 2022 / early 2023.
US 2yr Note
US 2yr Note
When we look at longer term bonds: 10-year & 30-year. The picture has changed.
The balance zones have broken and the expectation is for lower interest rates. 
10-year is indicating a potential move to ~ 0.84%! 
30-year has potential for a move to ~ 1.30%!
If long bond interest rates continue to drift lower there could be 2 impacts:
1. The yield curve could continue to flatten. A flattening yield curve could signal a slow down in the currently strong economy.
To learn about how the yield curve signals changes in the economy. Read our post, “How the Bond Yield Curve Moves Markets.”
2. Mortgage rates will continue to be low and corporations can continue to refinance their debt at lower yields.
US 10yr Note
US 10yr Note
US 30yr Bond
US 30yr Bond
Take away: Bond investors continue to struggle with low interest rates. Borrowers get the benefit. Watch the yield curve.
Stocks
Stock indices remain near all time highs, but with the bullish seasonal window closing the indices could see a bumpy retreat in August.
Bigger picture, the game remains the same. As long as the Federal Reserve is accommodative with low interest rates, the trajectory points higher. Even the “Bond King” Jeffrey Gundlach agrees. Recently he was on CNBC saying, “Stocks can stay at nosebleed levels as long as the stimulus continues.”
There is still the overhang of COVID thanks to the Delta variant. Yet, the Fed is more important. If vaccination rates climb COVID will move farther in the rear view mirror.
S&P 500
S&P 500
Take away: Watch for volatility near term. Longer term trend points higher thanks to the Fed.
Bitcoin
Bitcoin has now spent ~ 50 days in a consolidation phase. For now, bulls and bears are squaring off as they change and/or build positions.
If readers want a price level to watch as a trigger to lower prices - keep an eye on $29k (yellow). $24k would be the next stop (red).
BTC / USD
BTC / USD
Take away: Bitcoin buyers may still get lower prices.
Wrapping Up
Our hopes of a move higher in interest rates are on pause. It appears they will remain depressed thanks to potential seasonal equity weakness, COVID and the Fed.
Long term holders of equities should prepare for volatility. But generally speaking, things look to be on the up and up. At least until the Fed starts to pull back on liquidity.
Please reach out to us if you have questions, or if you want to talk about markets.
Did you enjoy this issue?
The InterPrime Team

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