Credit up

We look again at the list of 105 non-investment grade stocks that we highlighted back in late March as indicative of sorry news to come. That list was then expanding by the day and those stocks were falling fast on the view that frozen debt markets would not want to come to the rescue of basket cases.  

One month later things look rather more positive, courtesy of States and Central Banks providing liquidity. The list is down to 103 as two stocks are no longer listed or covered but the interesting point is that two issuers are back to investment grade status (ams and Dixons).  

We looked at the relative performance of those 103 names (o/w two IG issuers). Hallelujah, as from early April, a spring breeze came to the rescue of those names. The following chart tracks the unweighted relative performance of those 103 issuers. The low relative point was on 31 March.  

NIG stocks stopped falling faster than the market

Clearly with Central Banks buying into investment grade corporates and governments backing up to 100% of liquidity provided by banks to large issuers, liquidity risks evaporated and led animal spirits to contemplate NIG-type stocks as likely to see the benefits of functioning debt markets, even at the cost of eye-watering spreads.  

Seen with equity eyes that liquidity easing development is turning those stocks into call options, i.e. the bet that equity holders entertain that the debt will be paid back with a considerable positive leverage on the equity value as a result.  

Well, not dying now because of functioning debt markets does not mean that operations will be such post COVID-19 that solvency risks are sorted. The extreme case is that of Airlines and makes the point easily: ramping up the business back to a new normal is now expected to take about three years and a new normal is anybody’s wishful thinking about how wealth is going to be shared. Debt holders may get their money back, staff will not all be fired but shareholders are unlikely to run the show. Airlines are an extreme case, but it certainly borders on delusion that debt will be repaid easily in a no-growth/new economic model context so that debt conversion will be the norm.

In short, it is good that public money has saved the day but the underlying businesses are likely to hurt their shareholders beyond fast money.

Below is a summary of the risk-reward. We would not chase the 10% potential extra return vs. buying the market.

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