In The Headlines
High Yield Debt Market Woes: Echoes of 2008?
A day after a prominent Wall Street firm shocked investors by freezing withdrawals from a credit mutual fund, things only got nastier in the junk-bond market. Prices on the high-risk securities sank to levels not seen in six years and, to add to the growing sense of alarm, billionaire investor Carl Icahn said the selloff is only starting. “The meltdown in High Yield is just beginning,” Icahn, who has been betting against the high-yield market, wrote on his Twitter account. Icahn’s comments come as junk-bond investors, already stung by the worst losses since 2008, are the most nervous they have been in three years after Third Avenue Management took the rare step of freezing withdrawals from a $788 million credit mutual fund.
The risk premium on the Markit CDX North American High Yield Index, a credit-default swaps benchmark tied to the debt of 100 speculative-grade companies, rose 36 basis points to 514.52 basis points, the highest since December 2012. BlackRock’s iShares iBoxx High Yield Corporate Bond ETF, the largest fund of its kind, fell to the lowest levels since 2009.
The move by Third Avenue, announced on December 9th, is the latest omen of stress in a market already beaten down by a prolonged slump in oil prices that has battered the energy sector. The news came as the global appetite for risk is souring with the countdown to the Federal Reserve’s probable interest-rate increase sparking a selloff in equities and other risk assets. “The timing could not be worse,” said Peter Tchir, Head of Macro Strategy with Brean Capital LLC in New York. “Everyone is already nervous about liquidity, oil, the Fed hike—and you get this extreme event on top of it all. There is a lot of confusion. It’s put people on edge.”
Oil declined to the lowest level since 2008, exacerbating losses in high-yield energy debt, which makes up 12% of the broader market. Market woes have seen outflows from U.S. high-yield bond funds running at the fastest pace in more than a year as U.S. junk debt has declined 3.6%, the first annual loss since 2008, according to Bank of America Merrill Lynch Indexes. “Sentiment is heavy,” said Jerome Conner, who helps oversee about $52.9 billion as Portfolio Manager and Senior Investment Analyst at Federated Investors, Inc. Falling oil prices continue to weigh on markets, and “people see the Third Avenue headline and that contributes to the negative sentiment in the market,” he said.
The step Third Avenue took is unusual for a mutual fund, which typically offers daily liquidity to investors, and comes after regulators raised concerns that some mutual funds are investing in assets that could be hard to sell in a market rout. David Barse, Third Avenue’s Chief Executive Officer, said blocking redemptions was necessary to avoid fire sales. The fund, which had $3.5 billion in assets as recently as July of last year, suffered almost $1 billion in redemptions this year through November. The Third Avenue fund lost 13% in the past month and is down 27% this year, according to data compiled by Bloomberg. Assets have declined to $788 million as of December 8th, as clients pulled an estimated $979 million this year through November, according to Morningstar, Inc.
“It’s significantly bad news for the market, and another straw on the camel’s back,” said Martin Fridson, a money manager at Lehmann Livian Fridson Advisors LLC. “It’s not typical, but it raises the question: Can this happen to the next-worst fund? You just don’t know. It certainly doesn’t encourage people to put money in, and that just exacerbates the liquidity problem there.”
The weakness in the market comes as credit quality in speculative-grade debt is falling. For every junk-bond issuer that had its rating boosted this year, two have been downgraded, a ratio not seen since 2009, according to data compiled by Bloomberg. And companies are increasingly defaulting on their debt. Swift Energy Co.’s failure to make an $8.9 million interest payment last week raised the global tally of defaults to 102 issuers, a figure last exceeded in 2009, according to Standard & Poor’s. Bonds of Freeport-McMoRan, Inc. are also plunging. The copper producer’s $2 billion of 3.55% notes due 2022 dropped $02.5 Friday to $0.58 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. They yield 13.9%. Notes of mining company Anglo American Capital Plc also slid. Its $650 million of 4.875% notes maturing in 2025 fell $07.25 to $0.60 on the dollar, according to Trace. They yield 12.1%. As worries grow about the high-yield bond market, debt-market liquidity and the impact of cratering oil prices, many in the financial markets wonder if this is a signal of far deeper problems that may soon surface.
Nevada Morphs into an Energy Technology Hub
Every month another company, it seems, announces plans to build a factory in Nevada to churn out the future of energy technology. A year and a half ago, Tesla started building a massive battery factory, dubbed the Gigafactory, just outside of Reno. It has since been joined by a number of other high-tech companies involved in battery recycling, a futuristic transportation system, and electric cars. Nevada, known mostly for gambling, turns out to have a unique set of characteristics like the low cost of doing business, large incentives, the ability to move quickly, and ample clean energy resources that make it attractive to companies developing innovative energy technologies. It has slowly become a hub for the manufacturing of energy storage, clean energy, and greener transportation that could one day be as important as Silicon Valley is to Internet and software startups.
Secretive Tesla-rival Faraday Future has its sights on Nevada. The company said it planned to build a $1 billion electric car factory outside of North Las Vegas early next year if legislators approve a package of incentives and tax breaks. The startup, backed by Chinese Internet billionaire Jia Yueting, aims to build a three million square-foot factory on a 900-acre site that will churn out electric vehicles. Earlier, Nevada made the news again when Hyperloop Technologies revealed that in 2016 it plans to start testing an ultra-fast transit system known as a hyperloop on 50 acres of Nevada desert. Tesla CEO Elon Musk has popularized the hyperloop idea, which involves pods riding around on an air cushion through reduced-pressure tubes. Yet another company, Aqua Metals, a battery recycling startup, said it would build its first battery recycling factory on a site near Tesla’s Gigafactory. Aqua Metals, which recently closed on a loan to fund the project, has developed a more energy efficient process than traditional methods to recycle lead acid batteries—the kind that start up gas-powered cars (Tesla uses lithium-ion batteries for its cars).
In addition to the arrival of the energy tech companies, Nevada is at the forefront of clean energy projects including solar, wind, and geothermal farms. Apple built a data center outside of Reno, and has been building a solar farm about 70 miles away to help power its operations. A geothermal startup called AltaRock Energy bought a geothermal plant earlier this year about a hundred miles east of Nevada’s Black Rock Desert. The company is using its novel technology to enhance the geothermal well and help the struggling site pay back a loan backed by the Department of Energy.
Nevada’s attraction is that it has one of the lowest costs of doing business in the West. The state has no corporate income tax, minimal employer payroll tax, and land is relatively cheap. At the same time, the Bay Area and Silicon Valley are within a drive of just a few hours, enabling employees from companies like Tesla to quickly travel there from their headquarters near San Francisco. Because of the way the state operates, Nevada’s environmental and regulatory bodies can move more quickly than many other states. The political mindset is that government should get out of the way of business—a laissez faire ideology that explains the rise of the gambling industry in the state.
When Tesla’s Musk went looking for a home for the Gigafactory, he wanted a location where he could immediately start building the massive structure. He did not want to wait during a lengthy process other states require for meeting environmental reviews and regulations. For years, Nevada politicians have wanted to stimulate its economy and move away from its dependence on gambling. As a result, the state economic development agency has aggressively offered companies like Tesla big incentive packages to build their factories in Nevada. Tesla was able to acquire $1.4 billion in tax breaks, free land, and other benefits from the state.
Nevada’s abundance of clean energy from solar, wind, and geothermal farms also makes it attractive to companies like Tesla. Eventually, Tesla hopes to operate its battery factory entirely on clean energy, which would be difficult to do in other states that lack enough production of clean energy. Even excluding clean energy, Nevada is already home to low cost and reliable energy from natural gas. Such sources are necessary for energy-intensive factories. Furthermore, Nevada is rich in minerals that are critical to some clean tech companies. For example, the state has one of the few lithium mines in the U.S., producing a critical ingredient for batteries. Tesla plans to buy lithium from a mining project that is under development 200 miles from its battery factory.
With its growing mass of energy tech companies, Nevada now has an ecosystem that invites more to move in. Construction companies are building roads throughout the sparse, rural areas around the Gigafactory to bring in supplies and employees. Construction workers at the Gigafactory can continue onto other projects like the Hyperloop test track or the Faraday Future car factory. All of this is mostly good news for Nevada’s smaller cities like Reno. For years, it has been economically depressed and dependent on gambling and tourism. But now the city is morphing into an area with highly-skilled manufacturing jobs. And a significant part of those jobs are coming from the future of energy technology.
The Good News Is . . .
• U.S. import prices fell in November as the cost of petroleum and several other goods continued to decline, suggesting that cheaper crude oil and a strong dollar will keep inflation pressures from imports subdued for a while. The Labor Department said import prices dropped 0.4% last month after a revised 0.3% decrease in October. Import prices have declined in 15 of the last 17 months. In the 12 months through November, prices tumbled 9.4%. Dollar strength and a sharp decline in oil prices have dampened inflation, leaving it running well below the Federal Reserve’s 2% target.
• Leading fashion retailer, Nordstrom, Inc., reported earnings of $0.73 per share, an increase of 5.8% over year earlier earnings of $0.69 per share. The firm’s earnings topped the consensus estimate of analysts by $0.02. The company reported revenues of $3.1 billion, an increase of 8.9%. Management attributed the company’s results to higher than expected growth in its Nordstrom Rack and Nordstrom.com units.
• DuPont, the 213-year-old inventor of Kevlar, and Dow, the 118-year-old maker of plastics and chemicals, have announced a “merger of equals.” Shareholders of each company are expected to own half of the newly combined business, to be called DowDuPont. Under the terms of the merger, Dow shareholders would receive one share of the new combined company for each of their shares, while DuPont shareholders would receive 1.282 shares for each of their shares. Once combined, DowDuPont plans to split into three independent companies, each with its own specialty. The three businesses will include: one specializing in agricultural chemicals, with $19 billion in pro forma sales last year; one in plastics and other materials, with $51 billion in annual revenue; and a third in specialty products like those for electronics and nutrition, which would have about $13 billion in annual sales.
Guide to Changes in the Tax Laws for 2016
Every year it seems that Federal lawmakers make changes to the tax code. This year is no exception. Below are some of the tax changes that could affect you. Be sure to consult with your tax advisor to better understand and plan for these changes.
Tax penalties related to Obamacare are rising – The Affordable Care Act imposed penalties for those not having qualifying healthcare coverage. Those penalties started at $95 per adult, or 1% of income above the filing threshold in 2014, but they rose to $285 per adult, or 2% of income above the filing limit in 2015. For 2016, penalties will rise again, hitting $695 per adult, or 2.5% of income above the filing threshold. A family maximum will apply to the per-person amount, but the $2,085 amount will be substantially higher than the $975 in 2015.
Standard deductions and personal exemptions are going up – The low inflation rate kept standard deductions for most taxpayers steady in 2016 from 2015 levels, including the single, married filing jointly, and married filing separately statuses. For those who qualify as heads of household, the standard deduction will rise $50 to $9,300 in 2016. The personal exemption that taxpayers are entitled to take on their tax returns will go up in value by $50 in 2016. That will give everyone an exemption amount of $4,050.
Contribution limits on health savings accounts go up – Health savings accounts let people with high-deductible health plans set money aside on a pre-tax basis to cover the costs of their healthcare. For 2016, the contribution limit for individual policies will remain at $3,350, but the maximum contribution for family policies will rise by $100 to $6,750. A catch-up contribution of $1,000 for those 55 or older will continue to apply.
The Earned Income Credit goes up – The maximum allowable Earned Income Credit will go up modestly in 2016. For those with three or more qualifying children, the maximum credit will rise to $6,269, up $27. Those with two children will get a maximum $5,572, which is up $24 from 2015, while one-child families can get up to $3,373, $14 more than last year. Those without children get just a $3 bump and can claim up to $506 for 2016.
The exemption from AMT and the estate tax exemption are higher – The alternative minimum tax (AMT) has impacted a growing number of taxpayers, making the exemption amount more important than ever. Single taxpayers will see their AMT exemptions go up $300 in 2016 to $53,900, while joint filers will see a $500 boost to $83,800. The lifetime exemption amount for the gift and estate tax is tied to inflation, and it is slated to increase next year as well. The exemption amount will rise to $5.45 million—up $20,000 from 2015. The limit applies to estates of those who pass away in 2016.