The Dash for (negative) Yield at Wal-Mart

The idea of going for yield makes perfect sense; it is being encouraged by the wardens of our monetary system, it has continued to make a lot of money even as economic uncertainty has increased and despite trolls calling for a bubble in fixed income markets for years, prices have continued to soar.

Calling a top in the global dash for yield has so far been futile. Indeed, with ZIRP now a structural characteristic of the global financial system, one has to countenance the fact that the race to the bottom in global yields have only just begun. Consider for example the latest uptake for Wal-Marts bumper refinancing issuance schedule in 2013. Recent results on the earnings side and forward guidance have been less than impressive, but investors have still provided a healthy bid for the 2016 issuance. More spectacularly however, is this from Bloomberg; 

The company’s weighted average coupon of 2.09 percent on yesterday’s transaction is about half the 4.02 percent paid on its $3.69 billion of dollar-denominated debt maturing this year, Bloomberg data show.

I have no specific agenda on Wal-Mart here (no positions etc) and I have no real insight into whether Wal-Mart will do well or not so well in the coming 12 months, let alone looking as far ahead as 2016.

Crucially however, I don’t need to in order to point to the conundrum of the numbers above. 

Let me try to analyse this then from the point of view of the macroeconomist whose luxury it is to look at the big picture. We don’t need fancy charts, regressions or other advanced statistical methods. We only need two numbers. Inflation in the US is currently running at about 2% YoY and 5y to to 10y inflation expectations measured by the University of Michigan recently printed 3.3%. These two numbers are difficult to reconcile with the average coupon payed by Wal-Mart. 

Buyers of Wal Marts bonds at current prices are consequently, based on current inflation readings and long term inflation expectations locking in a negative real return.  This would be odd, but not unheard of in the context of sovereign bonds. Sovereigns have a printing press and especially in the context of elevated systemic financial risks, even negative nominal yields may make sense (mainly on the short end of the curve of course). In such situations, investors and in particular financial institutions merely seek certainty that the principal will be paid back and may even pay for the “privilege” to see such principal being paid out in freshly printed central bank reserves. 

But Wal-Mart is not a sovereign and does not, as far as your humble scribe is aware, have a printing press tucked away in their Bentonville basement. Indeed, Wal-Mart is a highly complex business with inherent risks and uncertainties. But it seems that the market is willing to dispense completely with this risk at the present moment. 

Of course, the story is not that simple and not even the macroeconomist can neglect microeconomic structures. Wal-Mart is a behemoth and any large fixed income manager need to hold its bonds to some degree, if only to not veer to much away from her benchmark. In addition, Wal-Mart still holds a coveted AA rating which is of course good for capital requirements in testing times such as these. Finally, Wal-Mart’s free cash flow is too good of a prize not to have a crack at and buying its bonds is of course, to some extent, a claim on this (well technically it isn’t of course, but you get my drift I am sure). All in all, the Wal-Marts of the world will always be able to find buyers of their debt, but this is not strictly the issue I am adressing here. 

As such, beyond all the reasons for why the Wal-Mart transaction makes perfectly sense in a well oiled big economy such as that of the US, the basic math looks a bit ridiculous in my view. Even if the supply of capital for Wal-Mart debt issuances is structurally deep and thus lends itself to the description of a very liquid market, we must pause to reflect the inelasticity of such capital relative to the price. Would there also be readily available capital for Wal-Mart refinancing at 1% or even at 0% or perhaps at -1%?

The answer is of course that such current fixed income “mispricing” is condoned and encouraged by monetary policy through the promise to keep benchmark rates at zero. Yet, this is hardly a very useful answer in the context of Wal-Mart and similar corporate issuances. Global and US fixed income managers are highly intelligent people with access to endless streams of historical and current information that would allow them to put a price on the business risk of Wal-Mart. Yet, such risk has been completely discounted in this case and the only thing we can say is that the dash for (negative) yield continues. I find this perplexing and it is a worrying sign for the global economy and her investors in my view. Higher rates as imminently unlikely as they currently seem would not go down well in the current investment climate.