Collateralize Loan Market Showing Signs Of Exhaustion

The S&P 500 is up 7.40% YTD and nearly all of the major investment banks have issued research reports making the case that equity market returns have been based more on metrics (lower P/E thanks to share buybacks fueled by low rates thanks to the FED) than what they should be based on, which is intrinsic earnings ability.  We also have Goldman Sachs GS patiently waiting for the expansion they have been expecting since March of 2014.  The rally from 2009 is being brought into question by more people as the year progresses on in light of weaker-than-expected economic data, weak-than-expected excuses for said data, and a lack of corporate earnings to support sustainable capital expenditures.  
The Container Store TCS and Lumber Liquidators LL have made it painfully clear to the rest of the street that weak economic performance isn’t mutually exclusive to weather based events and that correlation isn’t causation.  Both companies made very clear in releases last week that they witnessed poor performance because of poor economic fundamentals, not because of weather.
According to data from Capital IQ, investors appear to have little faith in the global equity rally, as flows into global equity mutual funds remains contained between $0 and $20M per month. Alongside that stagnate flow is evidence of investors seeking the perceived safety and stability of global fixed-income mutual funds.  

 

The environment currently appears to show the crossroads between two world views.  One is those who say “this is as good as the rally gets” and cut back market exposure.  Two is new converts exposing themselves to the market while saying “I’m warming up to equities, perhaps the rally is here now to stay”.  
The sustainability of a global recovery continuing to march onward through 2014 and 2015 without the backstop of central banking cash-flow seems very unlikely.  The Eurozone reported a 1.1 percent drop in industrial production this morning.  The weak reading will pose trouble for MSCI Eurozone Equity Market Price Return performance as the index remains near the upper-bound of it’s past roughly 20-year channel.
Weak economics coupled with a forward-pull to the present of future demand means the roaring 2009s to 2014s will be coming to an end as central bankers prepare to allow assets to be priced on intrinsic valuation instead of being priced as a means to alter and inflate euphoria and trust in the new world order of manipulated markets.  The Collateralized Loan Obligation market remains elevated as senior liabilities of Volker-compliant paper remains in high demand.  The S&P/LSTA Index loan data shows that new supplies match exactly with inflows from CLO formation and loan mutual fund flows at $8.7B.  That flow is sharply different than the $12B technical deficit (Change in Outstandings Minus CLO Flows) in May which was the most red ink the market has seen since November 2007 according to data from Capital IQ.  
June saw a hit to supply growth as the universe S&P/LSTA Index loans reached a record $756B, which was the smallest dollar increase YTD and well inside the average of $15.3B over the previous three months. 
As for demand in the CLO market, the average bud for S&P/LSTA Index loans increased an average of 0.13 points in June when compared against single-B loans, the largest and most consistent sample in the Index.  This monthly bid increase keeps the Index up but still below the recent peak of 100.28 hit back in Jan 2014 as demand tires and participants pause to gauge the resiliency of the market ahead of a FED culmination of monthly purchases.
Be prepared, informed, and in position before it's too late.  The FED will take action in the near future and whatever the FED does will have a profound impact on equity, bond, commodity, and currency markets along with structured paper markets.  I’ll leave you with a quote from the pseudonym  Alan Ashley-Pitt - “If you follow the crowd, you will likely get no further than the crowd”.
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