When analyzing the Federal Reserve officials’ comments, it is important to remember which FOMC member is speaking. Like George Orwell’s pigs, they are all supposedly equal, but some are more equal than others.
Stanley Fischer is generally accepted as Yellen’s wise lieutenant and second in command. As an economist, he taught at both Chicago and MIT. Stanley then became the chief economist at the World Bank and from there, went on to be the deputy managing director of the IMF. Finally from 2005 to 2013 he was the Governor of the Bank of Israel.
At the Bank of Israel he raised rates from the middle of 2009 to 2011.
Eventually all of these rate hikes had to be taken back, but that is a story for another day. Stanley is probably the only member of the FOMC that has actually pulled the trigger on a rate hike this decade.
Speaking yesterday at an economic conference in San Francisco, Stanley elaborated on the possibility of the Federal Reserve moving off the zero bound. From Reuters:
“In the relatively near future probably some major central banks will begin gradually moving away from near-zero interest rates,” Fed Vice Chairman Stanley Fischer told the San Francisco Fed’s biannual Asia Economic Policy conference.
“While we at the Fed continue to scrutinize incoming data, and no final decisions have been made, we have done everything we can to avoid surprising the markets and governments when we move, to the extent that several emerging market (and other) central bankers have, for some time, been telling the Fed to ‘just do it’.”
“We actually don’t take orders from other places,” Fischer added, but the fact that other central bankers are asking the Fed to get on with a rate hike indicates they have “made their preparations.”
Reading between the lines, Fischer is arguing the market is prepared for a US rate hike and it is fully priced in. Although I am not sure that raising rates will not end up eventually being a colossal mistake, we have hit a point where delaying a rate hike again will do more harm than good. The uncertainty of the liftoff will probably be worse than the actual hike. I continue to believe this December will result in the most dovish hike possible, and Fischer’s comments are in line with that thinking.
Buy the debt – not the equity
This morning I was watching Bloomberg TV and Oaktree’s Howard Marks was speaking about energy companies. I can’t remember the exact figures, but he speculated we would have 25% default rates amongst the energy space and 500 companies would go bankrupt. Marks is obviously way smarter than me, and I see no reason to quibble with his estimates. The oil and gas sector is a complete mess. There are too many companies, with too much debt, with too much hope built into the equity prices.
Yet that doesn’t mean there aren’t opportunities. Avenue Capital Group’s Marc Lasry recently highlighted the tremendous investment possibilities created by this stress. From Reuters:
Marc Lasry, chief executive officer of distressed investing specialist Avenue Capital Group, said energy debt offers a “once-in-a-lifetime opportunity” after plunges in oil and other commodity prices left many companies overleveraged.
Speaking at the Reuters Global Investment Outlook Summit in New York on Tuesday, Lasry said the amount of distressed debt in energy had grown this year to between roughly $250 billion and $300 billion from $100 billion.
He said that offers opportunities for patient investors not bent on making a quick buck.
“Energy today is a once-in-a-lifetime opportunity,” said Lasry. “Either you will get paid off, or you will become the new equity of these companies, but you need the luxury of time. You need to be able to wait two or three or four years.”
I happen to be an oil bull. But instead of buying energy equities, I think it makes way more sense to buy the debt.
The index of these high yield energy names is trading at distressed levels. That is 1100 basis points of spread! There is no way the energy companies will be able to roll their debt at those levels and survive.
Lasry is correct when he said the bondholders will become the new equity. And in the mean time, you get paid to wait.
Skip the oil and gas equities, buy the debt instead…
Thanks for reading and have a great wk-end,