The market has been roiled by claims of a liquidity crisis, stemming from inability to complete (ie find buyers for the ultimate bonds rather than the banks and initial financiaers) for highly risky leveraged bonds. Why does this lack of appetite for leveraged debt affect the market generally when there is still demand for good equity and debt? Is bad money chasing out good money with greed?
- Author:
- Published: Aug 23rd, 2010
- Category: Bonds Market
- Comments: 3
KevK
on Aug 23rd, 2010
@ 5:09 pm:
One of the reason lower priced (value) stocks enjoy richer values in this type of environment is becuase buyout capital is so cheap. So if a stock is trading below its percieved value, a LBO firm can cheaply borrow money to buy the company at a cheap price, (to be eventually funded by these risky bonds you mention) take it private, sell off pieces or turn around operations and then go public again at a higher price.
If the market for these “risky” bonds becomes illiquid, less capital is available to fund these buyouts. Less buyouts means the cheap stocks can stay cheap with a lower possibility of a LBO, so speculators do not bid up the stocks waiting for a buyout.
Bottom line, less access to capital for the LBO firms can indirectly mean lower stock prices.
Eggolas M
on Aug 23rd, 2010
@ 5:15 pm:
KevK is correct with regard to the buyout premium shrinking quickly.
However, another more insidious aspect of the CDO/CLO fallout is that lending standards are tightening across the board, causing interest rates on loans to increase.
That has one likely result and another that the market is concerned about. First, the higher interest rates will mean companies will have higher interest expenses (i.e., lower net income). Second, less available credit could mean a credit crunch and a slower economy (i.e., lower net income for companies than expected).
Coupled with KevK’s analysis, that makes three headwinds for the equity markets.
Of course, there are some other issues as well, but that’s a pretty good start for now.
Andy
on Aug 23rd, 2010
@ 5:17 pm:
KevK and Eggolas M are correct but remember that not all sectors are affected equally by the tightening of all that loose money the market has been enjoying. Month to date (as of yesterday’s close) the financials were down about 7% while the Nasdaq 100 was up 1%. Generally speaking, it’s time to avoid small company stocks — they tend to rollover their debt rather than pay it off so rising junk bond rates and tighter lending standards really hurt — and value stocks, which are predominantly financials.